Student loans – the seven deadly sins of early repayment penalties

Student loans – the seven deadly sins of early repayment penalties

Student loans – the seven deadly sins of early repayment penalties

Student loans are currently a good debt, there’s no ‘real’ interest cost and you only repay if you earn enough and the debt’s wiped after 30 years or so (depending when you took it out). Yet a little debated clause in the new loan system has a big negative impact. So this week to do what I can, we’ve written a briefing note on the danger for politicians…

My main concern isn’t that students will need to borrow more and take longer to repay – whether right or wrong that’s a political decision, it only changes the size not the nature of the borrowing. My bigger concern is that some students will be charged commercial interest rates and penalites or even face a ban on repaying early.  

This has been done so it can be said the new loans are ‘progessive’, political speak for ‘the rich should pay more’. As the new system didn’t automatically do that, these clauses do it artificially, yet that seems to be the only real sense to them – it’s being done for politics sake not for rights or wrongs.  

The interest rates seem set in stone, but there’s still room on overpayment penalties, so here’s (a slightly tweaked) briefing note to politicians.

The seven deadly sins of student loan early repayment penalties

1. It flies in the face of private sector rules.

Everyone should be encouraged to repay their debts as quickly as possible. To penalise doing so is something we have rightly seen regulation against in the private sector.

Only a few years ago commercial lenders were banned from levying harsh redemption penalties and keeping people locked into loans. This year we’ve seen regulations forcing personal loan providers to allow individuals to overpay their loans if they want to.

For the government to do the opposite on its own loans, in an even harsher manner, sets a poor precedent.

2. It’s unpopular and not wanted.

As part of this research we polled users on what they thought about the situation. 6,566 took part in poll on the 8 February 2011, which asked:

"Should you be allowed to repay students loans more quickly? The government is currently discussing a ban / extra fees on repaying more quickly as otherwise loans would cost higher earners overpaying relatively less, and wouldn’t meet the test of being progressive."

of respondents thought students should be able to pay off their student loans whenever they wanted.

7% said overpayments should be allowed but with early redemption penalties.

6% wanted to ban overpayments so everyone has to repay at the same rate

Of course there has, so far, been little fuss over this, because other elements of the loan structure have taken the brunt of negative publicity.

3. It penalises people for good financial management and success.

Preventing overpayments penalises people for good financial management and post university success.

For years we’ve educated our youth into debt when they go to university, but never about debt. This structure exacerbates that, it is extremely poor financial education and goal setting for our student populatation.

We have already lost the stigma of debt; to also lose the stigma on the urgency to repay is potentially devastating.

4. For some it’ll mean commercial loans may seem cheaper.

The combination of higher interest rates and the inability to repay would actually mean some, who know they’ll earn more, would be better off with commercial borrowing, such as 0% credit cards or low interest loans without repayment penalties.

In itself that presents an ethical dilemma, surely the government shouldn’t be charging rates that can be undercut by commercial lenders. Yet more importantly commercial debt will only be cheaper provided the student earns the expected income after university. If anything goes wrong some will be left locked into high interest debts.

5. Student loans will no longer be ‘good debt’ for some.

For years when communicating about student loans we’ve been able to say ‘it’s good debt’ as it’s the lowest long term interest rate possible and repayments match ability to repay. Yet under the new system the higher rate of interest and inability to repay early means it’s simply more difficult to say this and mean it! This in itself will affect access as future students are put off university due to the structure of new loans.

6. It pressurises parents into stumping up so students don’t need loans.

Currently students don’t pay loans up front as the interest is set at the rate of inflation, so there’s no real cost. The onus isn’t on the parent, it’s on the student to repay. It’s for this reason parents need to be cautioned that it’s their child borrowing not them, so they shouldn’t hurt their finances to protect them.

Yet changing the system to charge some higher rates, alongside penalties or inability to overpay alters that equation. We will see parents pushed into stumping up for their children’s higher education even though they are adults at the age of being able to vote, pushing more parents into a financial mire out of guilt.

7. Higher repayment threshold means people are in debt for longer.

Under the ‘you start repaying at £21,000’ rule, people will be in debt for longer as they’re repaying less, with interest accruing at commercial rates. Combined with the ‘no early repay’ and ‘higher threshold’ measures this effectively becomes a trap to keep students in debt and unnecessarily paying interest for longer. 

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