Taking a look at your student loan statement can be a scary business. The sight of how much you owe and how much interest is being added each year can prompt you into thinking that something needs to be done about it. You may even be thinking about getting a bank loan to pay off your student loan.
Let me stop you right there. In this article, we will break down how student loan repayments really work. And once you understand the system, you will see why a bank loan may not be such a great idea.
Which student loan do you have?
You will be on Plan 1 if you are:
- An English or Welsh student who started an undergraduate course anywhere in the UK before 1 September 2012.
- A Scottish or Northern Irish student who started a course on or after 1 September 1998.
If you are on Plan 1, then the repayment threshold is currently when you earn £19,895 a year, £1,658 a month or £382 a week.
You will be on Plan 2 if:
- You started your course after 1 September 2012 in England or Wales.
If you are on Plan 2, then you’ll begin paying off your student loan when you earn £27,295 a year, £2,275 a month or £525 a week.
For both plans, you will pay 9% of the amount you earn over the threshold. This is important, so remember this.
Bank loan or student loan?
It may be tempting to clear your student loan. That annual statement may make you think that you have this huge, growing debt hanging over you. But in reality, that just isn’t the case. Confused? Don’t be.
In order to understand why taking out a bank loan to pay off a student loan would not be a wise move, we need to understand student loan interest.
Whichever plan you are on, the interest on your student loan is in line with inflation. So there is no real cost of borrowing, as what you are repaying is the rate of inflation. If you want a more detailed breakdown, check out our article on making sense of student loan interest rates.
So for Plan 1, the interest rate is the Retail Price Index (RPI) or the Bank of England base rate plus 1% (whichever is lower). At the time of writing, the interest rate is 1.1%.
When it comes to Plan 2, your interest depends on your income:
- £27,295 or less: RPI (currently 2.6%)
- £27,296 to £49,130: RPI plus up to 3%
- Over £49,130: RPI plus 3%
Therefore, if you were to directly compare a bank loan with a student loan, then you’d be looking at an average interest rate of around 7%, compared to a maximum interest rate of 5.6%.
Already, it wouldn’t make sense to get a bank loan to repay your student debt. And that’s before we look at how student loans really work.
How do student loans work?
The nature of a student loan is that your interest rate is in line with inflation and that it will eventually be written off. But also, your repayments are only ever going to be 9% above the threshold, no matter how much you owe.
So, say you have a student loan of £20,000 and you earn £37,295 a year, which is £10,000 above the threshold for Plan 2. Your annual repayment on your student loan will be £900.
Now, say your student loan debt is considerably bigger at £60,000. With a salary of £37,295 a year, your annual repayment will still be £900. It doesn’t matter that your debt is larger, it’s about how much you earn above the threshold.
You may be thinking that having that much debt hanging over you is an issue. But the impact of having it there won’t really change unless you are in the top 20% of graduate earners.
Basically, unless it is likely that you will be able to clear your whole debt and interest before your student loan is written off, there isn’t much point in overpaying.
You could be working day and night to clear a debt that will eventually be written off anyway. So it may make more sense to use that money to clear other debts or save and grow your money.
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