For many young people, going to university is a rite of passage. Despite it being one of the largest financial commitments (second only to buying a house!) the number of 18-year-olds aiming to go to university directly out of school continues to increase at a rapid rate.
Considering expensive it is in the long run, university is one of the largest economic decisions many people are likely to make. But exactly how much financial advice do young people get before taking out what will - in many cases - be at least 30 years of debt? And with inflation making repayments more expensive, is three years of education worth the price?
Punk Money Investigates.
What’s the current situation for students and graduates?
As recent data shows us, “the number of applicants from disadvantaged areas has also continued to rise, with 28% of 18-year-olds from areas with the lowest educational attainment applying, compared with just under 18% in 2013.”
We spoke to a group of recent graduates and students to better understand this to see how much they knew about their student finance and their feelings towards it. Of the students we spoke to, 50% stated they should know more about their student finances, and almost 70% had no idea how much interest was being charged.
It’s easy to see why. The terms and structure are unlike a typical loan. Instead, they are designed to be repaid through the company payroll system, similar to income tax (PAYE), and are charged at a fixed rate of 9% of everything you earn above a certain threshold. And, unlike taking out a personal loan or credit card, student loans have zero impact on your credit rating. More on this later.
Interestingly, the government only expects 25% to pay their loans back in full. Of the students we spoke to, this seemed to be a fact that they were aware of:
Nicholas from Hackney said: ‘Well, most people never really have to pay it back their full loans as it gets wiped off in 30 years, so you just don’t worry about it”
While technically this is true, in that only 30% of loans are repaid in full, it means that the vast majority of people only ever repay the interest on the loan and the principal of the loan at a rate of 9% of their earnings for 30 years (40 years after 2023).
A quick overview of how the loans from student finance England work
Currently at £27,295, but this is set to be lowered to £25,000 for those borrowing after September 2023. The loan repayments are automatically deducted from your income until it is paid off or after 30 years when it is written off, whichever comes first.
A calculation made through this student loan calculator tool for an average student debt of £45k and an average graduate starting salary of £25k showed that the loan would balloon to over £100,000 by the time it was eventually cancelled after 30 years. During that time, the repayments of the loan peaked at over £4k per year.
In 2023 the cost of student finance will rise for many as the payback terms are increasing to 40 years before it is cancelled, which will see 52% of graduates paying back their loan well into the twilight years of their working lives and will be repaying over double what they’d originally borrowed.
Interest rates are calculated for loans taken out since 2012 (plan 2) based on your current salary. Whilst you are studying, the debt you have currently accumulated will have an interest rate of the Retail Price Index (RPI) plus 3%. RPI is a measure of inflation, and the 3% adds an extra fee to the interest rate. If you started university before 2012, you received a Plan 1 loan, and you’ll pay 9% of all pre-tax income above £19,390. Plan 1 loans have a flat interest rate of 1.1%.
So, what does this mean in a time of rocketing inflation, since the office of national statistics has set the RPI to 12.3% in July 2022. Thankfully, the Student loan interest rates will now be capped at 6.3% from September 2022. The government intervened in June to protect borrowers in response to the rise in the rate of RPI due to global economic pressures which meant student loan borrowers faced a 12% interest rate in September. The National Institute of Economic and Social Research says the RPI is set to hit and astronomical 17.7% by the end of the year which would have made student loans more expensive than many credit cards if the cap wasn't in place.
After a student graduates, how the interest rates operate varies on your income. If you earn less than £27,295, only RPI is applied. This would mean that if you got the average graduate wage of £25,000 and spent three years earning below this threshold you would owe over £60,000 before you started paying it back.
What makes a Student Loan different from other debt?
When you take out a personal loan, a credit card or an overdraft, the lender you borrow from will carry out a credit check, which will determine how much they are prepared to lend you and at what interest rate.
However, one of the key ways a student loan differs from standard loans is that they don’t appear on your credit history: the debt you take on while at university won’t impact your ability to take out other forms of credit like personal loans or credit cards, and lenders won’t know how much you’ve paid or need to pay off.
This is a debt that will be with you throughout most of your working life and although your credit report isn’t impacted, mortgage providers may ask about your monthly outgoings. How much you’re paying towards your loan per month can therefore impact who lends to you depending on how much of your income it represents.
Where do students go when they run out of money?
Even with borrowing an amount that could be a down payment on a house, 20% of students run out of cash when university.
According to Savethestudent.org 32% of students said they use their student overdraft as a source of income. Many banks are offering up to £3,000 as student overdrafts that could be interest free (depending on your credit score) while you’re at university. But, once you’ve graduated the average cost of an overdraft at a high street bank it 39% so you can see how this source of free money could quickly turn into a black hole of debt.
On top of that, 51% said they turn to banks when they're in need of emergency cash. Many students have other forms of debt alongside student loan borrowing with the amounts owed in commercial and high-risk credit (credit cards, payday loans etc.) being substantial.
Of course the other trusty source of cheap finance is the good old Bank of Mum and Dad, with many students turn to their parents. If your family can afford it this is a great source of finance but it’s not without it’s pitfalls, being clear on what is a gift and what is a loan is really important to make sure that everyone is on the same page. Parent’s might be dipping it their savings that they would like to rely on later in life so may expect to be repaid. But if it’s all clear then loans from family or friends can be the cheapest form of credit available with rates as low as 0%.
Is is worth it?
“The debt levels faced by young people wishing to attend university or buy a house would have been considered unimaginable twenty or thirty years ago, but it is a worrying reality for many especially in an era of low wages, declining pensions provisions and insecure jobs.’
Not only does this debt become normalised, but students and graduates appear to have little understanding of how the fees they pay are spent: “Minty (2015) for example notes how prospective students want greater transparency about how fee income is spent by universities” Despite high levels of student satisfaction, a study by UUK found “there was a clear concern among current undergraduate students about whether their financial investment represents value for money.
46% feeling their university experience had been poor value for money
After university, when graduates start repaying their loans. It could be assumed that graduates would better understand their debt and how to manage it. But this doesn’t seem to be the case.
Jack from Aylesbury said: “I’d like to have heard realistic expectations of the loan's impact on my paycheque and hear from past graduates. Understanding the different types of repayment options available and any strategies for lowering the payment would be useful, but as it is, I dont’ know”
To manage your student loan you can sign in here on the Student Loans Company website. Here you can find the total amount you owe, see the amount of interest that’s been applied, and manage your payments. Repayments are automatically deducted from graduates' paycheques if they qualify. However, students can also set up direct debits or one-off payments.]
So, should you pay it off faster if you can?
As outlined on the government website, it’s unwise to make ‘voluntary repayments if you do not expect to fully repay your outstanding balance by the end of the loan term’. Voluntary repayments can’t be refunded; spare cash you have is better put towards a house deposit, savings or investment.
As an example, if your yearly salary starts at £22,000 and goes up to £43,923 in the 30 years, even though the debt will balloon to £97,630, you’ll only end up paying £15,351. Then the debt is written off. In this scenario, you would have wasted a considerable amount of money if, for example, a family member had decided to pay off the full £45,000 when you graduated.
What can you do instead? Say you save £5,000 in a year from your income, if you’re not going to pay off your student loan anyway, the payments won’t stop at £5000 less; you’ll continue paying on top of that extra repayment. But if you save the cash in an ISA or invest it you could earn interest on what you’ve earned.
Whether you make extra repayments ultimately depends on your financial situation, income and where you see yourself economically in the future.
Is there another option?
It might not be suitable in all cases but it is possible to finance university by other means.
Personal loans taken from Friends or Family members could step in to bridge the gap during these periods of high inflation. Furthermore, flexibility on payment terms and lump sum repayments could afford some graduates to repay their loans in full within a few years as opposed to having the burden of long term student loan debt as with the current system. We have a guide to how to borrow from Family and Friends here.
Before, during and after university, it’s clear that the students and graduates we spoke to had a lack of understanding about how much their student loan would cost to repay.
Education on student loans doesn’t just stop once students get to university, but it should follow throughout the loan's lifetime to make the best possible financial decisions.
Moving factors, like the interest rate, constantly changing for plan 2 loans, payments changing upon salary and the government making amends to the new repayment terms for students starting university in the next coming years does make it difficult to understand the details of the loan.
The idea that young people are encouraged to make such a huge investment while receiving very little in the way of financial guidance from schools, seems like a massive oversight. Paired with the “free” overdrafts and credit given to students by banks, debt could be normalised in a way that’s problematic for students while at university and throughout their financial lives.
Ultimately, he decision of whether or not the cost is worth the benefit is a personal one, but if you knew what it would be before you started it might make you work harder!