Why you shouldn't pay off your student loan

The cost of education is always reaching new highs – with standard university courses in the United Kingdom costing over £9,000 a year.

This has led to many taking out student loans to help pay for this unaffordable cost – to cover the £9,000 + in tuition in addition to further maintenance loans of £4,000 +.

This leaves students coming out of university with debts of around £50,000 when they leave university.

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The interest rates

Interest rates charged on the amount borrowed depend on your salary. At the time of writing – if you earn £25,725 or less the interest rate charged is equal to that of RPI.

RPI stands for Retail Price Index and tracks the cost of goods over time - a measure of inflation.

For those earning between £25,725 and £46,305 the interest rate is between RPI and RPI + 3%. This increases on a flat line so that for every £1,000 over £25,725 you earn, you’re charged an extra 0.15% interest.

And if you’re fortunate enough to earn over £46,305, you’ll be charged an interest rate of RPI + 3%.

These rates seem pretty steep when comparing to loans available with the current low interest rates. One may consider leveraging a low interest loan such as a mortgage to borrow more at a lower interest rate – however for most – this rate is irrelevant.

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Why you shouldn’t pay off your loan

In short, it’s because after 30 years your loan will be wiped. In reality, the average person will not pay off the loan in full in these thirty years due to how the repayments are calculated.

If you earn below £25,725, no repayments will be taken. If you earn over £25,725 – your repayment will be equal to 9% of everything over £25,725 that you earn.

Therefore, for most, it’s not worth paying off chunks of the loan in advance – as you’re better off treating the payments as an extra tax out of your wage slip.

The inconvenient truth is that you'll likely never pay off the loan and would be better off financially making the minimum payment as calculated above - each payday.

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The exceptions

There are a few for whom paying off a student loan is worth it. This is the select few who have landed high paying jobs and are expecting to experience high wage growth. For these people they’ll be charged the highest interest rates and will likely end up paying the whole amount.

In this case it makes sense to pay off chunks of the loan as soon as possible, else you’ll be borrowing the money at a high interest rate of RPI + 3%.

This would be the only situation in which it would make sense to take to leverage debt in another asset class you hold (such as in the form of a re-mortgage against a property), to pay off the loan.

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