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.
What are Your Options?
- Pay the minimum requirements (as described here)
- Overpay to reduce or clear your debt earlier, by making voluntary payments to the Student Loans Company
Weigh up the pros and cons, and get proper advice before you decide.
According to Martin Lewis (Money Saving Expert):‘Even at 6.1% 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.’
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 charged the highest interest rates and who are set to pay off the whole loan within the 30-year period. Early repayments mean your debt 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 unnecessarily paying debt that would have been wiped after 30 years.
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.
Considerations & Drawbacks of Overpaying
Loan write-off
Most graduates won’t have to fully repay their student loan.
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 clearing your debt early means you could end up paying more than you needed to!
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 later at higher commercial rates (for a car, laptop, furniture etc.).
Also 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.
Would you be better off by saving?
If the interest rate you can earn from savings is higher than the interest rate you pay on your loan, it makes 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 costly commercial loans at a later date.
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, directly to the Student Loans Company.
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