If you’re concerned about being in debt and alarmed by rising interest rates, you might be tempted to clear your student loan as fast as possible if you have spare cash. But it’s important to understand that your student loan is not like normal debt, and is likely to be one of the safest, cheapest loans you will ever get, so it’s not always wise to pay it off early, even if you can afford to.
The interest added to your student loan will increase your overall debt, but it won’t affect how much you repay each month, because repayments depend on what you EARN and not on what you owe. Many people won’t pay all the interest added to their debt before it is written off, and lower earners will pay no interest at all.
Under the new Loan Plan 5, it is expected that 52% of graduates will clear their loans plus all the added interest; but as the interest rate is equal to inflation, there is no real cost to the loan.
What are Your Options for Repaying Your Loan?
- Pay the minimum requirements (as described here)
- Overpay to reduce or clear your debt earlier, by making voluntary payments to the Student Loans Company
According to Martin Lewis (Money Saving Expert):Even at 7.3% interest, ‘the only people who should be overpaying their student loan debt are high earners, free of other debts, who’ll never want a mortgage or other loan.’
The pros and cons of overpayment are explained below.
Considerations & Drawbacks of Overpaying
Your student loan could be wiped before you have paid it off
Many people won’t have to repay the full amount they owe, especially if you have a Plan 2 loan.
Less than a quarter of graduates are predicted to pay off their Plan 2 loans (and they will be the highest earners). Even if you are earning a high salary early on in your career, your circumstances may change; and if your income drops, part of your student debt could be wiped after the 30-year payback period. So, if you make early voluntary repayments, you could end up paying more than you needed to!
Even Under Plan 5, where over half of graduates are likely to pay off their loan within the extended 40 year period, it might not be wise to clear your student debt quicker than necessary; for example if there’s a chance your situation might change with a career break or change of direction. Or you might be able to put your spare cash to better use.
Read the points below, and if necessary, seek financial advice before making a decision.
Compare costs of other borrowing
The higher the interest rate, the faster a debt grows.
Most types of commercial borrowing (e.g. personal loans, credit, store cards or overdrafts) charge far higher interest rates (APR) than student loans, which means they cost you more. So clear your more costly debts first, before paying any extra off your student loan. (Just check for any early settlement penalties on loans).
Avoid higher costs of future borrowing.
If you hurry to pay off your student loan, you risk needing to borrow more later (e.g. for a car, laptop, furniture, or to set up a business etc.). Not only will you pay much higher commercial interest rates, but there could also be hefty arrangement fees, and penalties for missing repayments. Remember commercial borrowing requires regular repayments even if times get tough, whereas you can just stop repaying your student loan if your income drops below the threshold.
So, if you are likely to need to borrow in the future, rather than overpaying your student loan, consider putting the money into savings, in order to minimise costly commercial borrowing.
Would you be better off by saving?
If the interest rate you can earn from savings (after tax) is higher than the interest rate you pay on your loan, it could make sense to put your spare cash into savings rather than clear your student debt.
Example:
What will make you better off – put £2000 in savings or clear your student loan?
£2000 in a savings account paying 5% tax-free interest could earn you £100. (5% of 2000 = 100)
£2000 paid towards your student loan, if interest is charged at 3%, will save you £60. (3% of 2000 = 60)
So you would be £40 better off from saving, than from repaying your loan.
Putting spare money into a Cash ISA or high rate savings account could leave you slightly better off than paying back extra on your student loan. And having some savings to fall back on means you might avoid taking out expensive commercial loans at a later date. Alternatively, you could invest your money, or consider saving towards a mortgage rather than rushing to pay off your student loan.
Benefits of Overpaying
Less debt
You will be debt-free earlier.
Reduce costs – the faster you clear your debt, the shorter the time you pay interest.
This is an important consideration for big earners, who are set to pay off the whole loan within the write-off period (particularly Under Plan 2 where they are charged the highest interest rates). Paying off your loan early means it accrues less interest and could potentially save you thousands.
However, if it’s doubtful that you would clear your loan with normal repayments, then overpaying is not such a good option – you could be throwing money away on a debt that would have been wiped after 30 years (Plan 2), or 40 years (Plan 5).
Mortgage applications
If you are applying for a mortgage, you may well secure a better deal if you don’t have loan repayments to be taken into account for affordability checks.
Whilst there are valid financial reasons for not clearing your student debt earlier than necessary, ultimately you should do whatever makes you comfortable. Weigh up the pros and cons, and get proper advice before you decide.
How to Overpay or Clear Your Student Loan Early
If you do want to pay off your student loan more quickly, you can make voluntary repayments at any time, in various ways directly directly to the Student Loans Company.
Find out more:
‘Student loan interest rates: ‘Should I panic or pay it off?’ – Money Saving Expert
