Stop early redemption penalties on student loans: the MSE consultation feedback
The student loan system’s undergoing a radical overhaul that’ll hit new 2012 starters and beyond (not current students). Much has already been decided, such as the new £9,000 fee limit – but there’s still a proposal to levy penalties on those repaying early, which I think is wrong.
Last week we (MoneySavingExpert.com) submitted a consultation paper on the matter. It’s already been decided you should be allowed to repay early, but now it’s all about penalties.
While, I head up the sexily named Independent Taskforce on Student Finance Information for England – and focus on explaining the impact of the changes, not the policy (see Student Loans 2012) – I’ve consistently been against these penalties (see my Seven deadly sins of early repayments blog) and think it’s important to explain them.
The submission is below – edited slightly to fit the blog format…
MoneySavingExpert.com submission on Early Repayment Charges
It is our view that early repayments must be allowed, and as with the current system we fundamentally oppose any early repayment penalties for the following reasons:
It is mis-educating people on how to treat their debts
For 20 years we have educated people into debt when they go to university and are due to take student loans, but never about debt. To now prevent people from repaying their student loan early, where it benefits them, adds insult to injury.
In many ways the problems with the new student finance system are psychological more than practical. Even though many students will be better off not overpaying (see appendix) the psychological damage of banning them from doing so needs to be factored into any decision.
Adding early repayment penalties flies in the face of private sector rules
To penalise overpaying on loans 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 more harsh manner, sets a poor precedent.
It’s unpopular and not wanted
We polled MoneySavingExpert.com 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."
87%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, but this could equally have negative long term financial effects on many students.
It penalises people for good financial management and success
It is easy to see high earners after university as ‘rich folk’. Yet one of the gains and aims of higher education should be social mobility. Not all the successful people after university come from affluent backgrounds.
If repayment penalties are put in place, preventing overpaying penalises people for good financial management and post university success.
For some it’ll mean commercial loans may seem cheaper
The combination of higher interest rates and penalties to repay would actually mean some, who think they’ll earn more, may consider that they will be better off with commercial borrowing, such as 0% credit cards or low interest loans without repayment penalties.
Yet more importantly commercial debt could be cheaper provided the student earns the expected income after university and then has the ability to overpay substantially. If anything goes wrong some will be left locked into high interest debts – which they wouldn’t have needed to repay anyway.
It pressurises parents into stumping up so students don’t need loans
While the responsibility isn’t the parents to repay, but the graduates, many parents still feel it is their job to fund their child through university and prevent them from getting into debt.
Parents need to be cautioned that it’s their child borrowing not them, so they shouldn’t hurt their finances to protect them. Yet in the meantime, changing the system to charge penalties, alongside higher rates, exacerbates the problem.
We will see parents pushed into stumping up for their children’s higher education – some anecdotal tales are already coming in of parents planning to borrow themselves rather than let their child take a student loan. (See the Don’t pay tuition fees upfront guide – ML).
While communication about the system should help prevent this, that is a long term aim. Yet the introduction of early redemption penalties will force people to make this decision even before fully understanding the consequences.
Suggested Protective Measures
We strongly object to early repayment penalties for all graduates regardless of earnings, however, if they are to be implemented, at the very least the following protective measures must be put into place before the system is launched.
A penalties holiday must be given at the point payments start
Full time undergraduates become eligible to start repaying in the April following graduation. If penalties are introduced we would strongly urge that a short term penalty holiday is allowed at this point.
This is to solve the specific mischief of those who are debating whether to take out tuition fees at all. Currently it is a gamble for the individual (or their parents) as paying upfront is only worthwhile for higher earning graduates, but to know how much that will involve requires a crystal ball.
If there are early repayment penalties, it further forces parents or students to risk paying the loan upfront unnecessarily. Allowing a one-off get out of jail free card to pay the money back allows people to forestall their decision until the point of graduation where future salary is likely to be easier to predict, rather than needing to make an all-or-nothing decision based on very little information before studying.
This measure would allow those who are planning to use savings, or worse take commercial loans, but are unsure about their future, to hold off from paying the loan upfront and wait until they can see the likely benefit of their education more clearly.
Therefore an opportunity at that time to repay some or the entire loan off without penalty would at least provide some respite.
Students must be informed about the cost of an early repayment before doing it
Joint suggestion by the National Union of Students and MoneySavingExpert.com
Whether repayment penalties are introduced or not, it is important students understand the impact of their repayments – as for many it will be a futile gesture. Further explanation as to why is in the ‘most students shouldn’t overpay’ appendix below.
The Student Loans Company, on receipt of an application to repay early, should be mandated to produce a quote on the impact to the student. Based on their current salary it should be signed and returned before the money is credited to the account. The quote should contain two key factors:
- The cost of the penalties. If penalties are introduced the exact cost should be spelt out and explained.
- The gain from overpayment. This should take the form of typical circumstances based on inflation and a variety of earnings growth scenarios which show the amount overpayments will reduce the total cost. In a substantial number of cases this reduction will be zero as there is no gain from repayment.
For illustration (this is for example only – work needs doing on communicating it):
Based on your current salary of £25,000 and outstanding loan of £35,000…
At 3% inflation with additional earnings growth of 3%, by overpaying £1,000, in today’s value it will reduce your total repayments by £0.
At 3% inflation with additional earnings growth of 6%, by overpaying £1,000, in today’s value it will reduce your total repayments by £0.
At 3% inflation and additional earnings growth of 9% overpaying £1,000, in today’s value it will reduce your total repayments by £1,800.
The overall impact of adding penalties
The changes seem to have been made simply so it can be said the new loans are progressive for the sake of politics to assuage think tank assessments on the system, not the practical impact on graduates nor the educational message it sends.
While lower income graduates may be less inclined to overpay and high earners will not see the penalties as a barrier, it is the middle payers that are the most disadvantaged as they are not getting the chance to catch up.
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 potential for repayment penalties means it’s simply more difficult for us 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 and this deeply concerns us. While it is something we will continue to work at explaining, the barriers will already be in place unless the overpayment penalty plans are scrapped.
Appendix: Most students should not be repaying early
The simple fact is that, under the new system most students should not be repaying early.
We believe they should have the choice to do so if they wish, but that there should be no detrimental effect or additional cost.
As it stands, there are too many variances for each student to know what will happen in their future in order to determine the actual cost of their education, but as we will show below most will gain by not repaying and this must be made clear to anyone potentially wanting to do so.
Why most people shouldn’t pay off early
Early repayments are a bad financial move for many students. Repayments are based on earnings (9% of everything earned above £21,000) and all remaining debts are wiped after thirty years.
This means there are many who will never repay in full and may find themselves clearing a debt that they would never have needed to repay.
A graduate on a typical starting salary (£25,000) which rises at 2% above inflation for 30 years, who has taken the full £9,000 tuition fee and away from home (non London) maintenance loan of £5,500 would have accrued total borrowing of around £43,500.
According to www.studentfinancecalc.com their real term repayment over the 30 years before the debt is written off would be £24,940 – far less than their original borrowing. So in the vast majority of circumstances any overpayments made wouldn’t reduce the amount paid back – therefore it’s a waste of money.
The only people who stand to gain from early repayments are therefore those on higher incomes.
Many people wrongly pay off early
While the clinical financial logic above shows people shouldn’t try to overpay – they do. Under the current system the average median salary of people who overpay is just £18,400.
While this is likely to be pushed up under the new system, it still means many who pay early will already be financially penalising themselves, to add to that with penalties is a mistake.