You graduate from uni, ready to face the world – check your student loan statement online and discover £150 a month interest is being added. It’s a frightening prospect. However, for many people this statement and the interest added is irrelevant and may as well be ignored.
I’ve often heard it said that all English students in England who started university in or after 2012 pay above inflation rates of interest. That isn’t strictly true. Many have above inflation interest added to their statement – however, that isn’t the same thing. This subtle nuance has a huge impact.
It’s not easy to explain though, so I wanted to bash out a step-by-step explanation. First, a quick summary of where we are with interest rates…
Student loan interest rates for post-2012 students.
It’s worth reading my full Student Finance Mythbusting guide before carrying on with this blog, as it’ll answer many of the questions that you may have while reading this.
- Student loan interest rates are based on the RPI rate of inflation. RPI is the measure of inflation used for student loan purposes. While we get a new measure of RPI each month, the student loan rate changes only once a year, in September, based on the RPI in the prior March.
– The March 2015 rate was 0.9%. That is currently in play for the 2015/16 academic year.
– The March 2016 rate was 1.6%. That will be in play from September for the 2016/17 academic year (technically that’s not confirmed yet but it has always worked this way).
- The rate for students in the 2015/16 academic year is RPI + 3% so that’s 3.9%.
- The rate for students in the new 2016/17 year is RPI + 3% so that’s 4.6%.
- After graduation the rate is between RPI and RPI + 3% depending on earnings. Earn £21,000 a year or less and it’s RPI (currently 0.9%). Earn £41,000 or more and it’s RPI + 3% (so currently 4.6%). Earn in between and it’s a sliding scale between the two.
- A full student loan can be £44,000 which means £140 interest a month added while studying. For someone who started in 2015 with £9,000 tuition fees and the full living away from home maintenance loan (not London), they’d borrow just over £44,000 over three years. At RPI + 3% (so currently 4.6%) that’s roughly £140 interest added a month. For those who’ve graduated and earn higher salaries the interest will be higher.
|Started uni before 2012? Your interest is different; I explain in my Should I pay off my student loan? guide. That also means the rest of the calculations don’t relate to you. This is a guide for post-2012 students.|
Having read these ferocious stats, you’ll probably have sympathy with the recent viral letter that went round by student Simon Crowther about unfair hikes in interest rates for students (see my The viral letter about mis-sold student loans is well meaning, but wrong blog on it).
In fact, since the change in 2012, there haven’t been any hikes. The student loan interest rate has always been based on inflation and for post-2012 students it was always going to be above inflation. Though some, including Simon, have raised questions over whether that was correctly communicated to all prospective students before 2012.
In fact, the really nasty change that is happening isn’t over interest rates but over the threshold of repayments, which I’ve been campaigning against. And today that is being debated in Parliament, see my Tell your MP to fight the retrospective student loan hike guide.
OK, enough of this waffling preamble, you say the interest is nonsense – why?
Let’s get on with the meat in this sandwich. One of the phrases I’ve said about student loans since 2012 is that the price tag and the amount you actually pay are completely separate. That’s because, no matter how much you borrow or how much you owe…
You only repay 9% of what you earn above £21,000 and whatever is owed wipes 30 yrs after graduation.
For most people it is this and this alone that dictates what you pay.
The only impact your borrowing and interest has is whether you’ll clear the loan in the 30 years before it wipes – and all but the highest earning graduates WON’T do that. So for everyone else the statement of what you owe is nonsense; forget it.
I know many will be struggling to get their heads around this. So let’s start with an easy example about course fees, and oversimplify it by ignoring interest and inflation, pay rises and other variable factors.
Which of these two is the most expensive degree?
1. Tuition fees £6,000/yr. Maintenance loan £4,000/yr. Total owed over three years £30,000
2. Tuition fees £9,000/yr. Maintenance loan £4,000/yr. Total owed over three years £39,000
The answer here on paper is, obviously, the second course, it’s £9,000 more expensive over three years. However, in practice, what you really owe is dictated by how much you earn. Regardless of which course you took – you repay 9% of everything above £21,000.
Here’s the working…
– For someone earning £30,000 a year
– They repay 9% of £9,000 (ie, £30,000 – £21,000) = £810 a year
– They repay for 30 years so the total repayment is £810 x 30 = £24,300
In other words, in both scenarios, this doesn’t repay enough to clear the original borrowing. So both courses cost you the same, even though the second one has a higher price tag.
It’s only higher earners who earn enough to repay more than they borrowed within 30 years, so for them the second course is actually more expensive. So for most, borrowing more for student finance doesn’t cost them more (though, of course, it does mean the state is footing a larger share of the bill).
Why interest is mostly irrelevant for many.
Having interest added works in a similar way to larger borrowing. It is only those people who will earn enough to clear what they borrowed within the 30 years who will ever pay the interest.
And more so, for anyone who won’t clear all they borrowed PLUS the interest within the 30 years – then the amount of interest on your account in practice is irrelevant, as you’ll repay 9% of everything above £21,000 for 30 years anyway, so the statement is meaningless.
It is of course difficult to predict exactly who falls in these categories as…
- Repayments vary with higher earnings
- The interest rate varies with average earnings
- Income changes over the years
- Some may have periods off work (maternity or paternity leave, for example)
- Sadly the Government may change some of the thresholds later on
However, you can see the scales of magnitude by playing with our How much will student finance really cost? calculator. As a rough estimate for someone taking a £9,000 tuition fee course and full maintenance loan over three years…
– To clear what you borrow within 30 years: You need a STARTING SALARY of roughly £30,000 and then 2% above inflation pay rises each year after (difficult to calculate this one so it’s a guesstimate).
– To clear what you borrow and interest within 30 years: You need a STARTING SALARY of around £40,000 and then 2% above inflation pay rises each year.
As you can see that means for all but the highest earning graduates the interest on student loan statements has no real practical impact. It’s far better just to accept “I’m going to pay 9% of everything above £21,000 for the next 30 years” and think of it more like an extra tax. And by viewing it as a tax it’s actually a much easier way to understand its likely impact.
If you think of student loans as an extra income tax – here’s what you’d pay…
|Without student loan||With student loan|
|Earnings under £11,000||Nothing||Nothing|
|Earning £11,000 – £21,000||20%||20%|
|Earnings £21,000 – £43,000||20%||29%|
|Earnings £43,000 – £150,000||40%||49%|
NB: Nerdy point – most should skip. It’s worth thinking about inflation too. Inflation is the rate at which prices rise. So if you borrowed enough to buy one shopping trolley’s worth of goods, and the interest was set at the rate of inflation, in the future you’d only need to repay enough to clear one shopping trolley’s worth of goods.
So in fact if you don’t repay enough to clear the original loan plus inflation – then actually in real terms you’re still repaying less than what you borrowed.
Why this is so important to understand
I’ve not written this blog to say “student loans are really cheap, don’t worry about it”. They’re not that cheap, many on middle or higher salaries will pay large amounts back, but hopefully the gain financially, culturally and socially from your education will be worth it.
I’ve written this to stop people making bad financial decisions. Many are panicked about the interest building up and ask me what they can do. Should I try to pay more off? Yet, hopefully, from reading this blog you see actually overpaying for many wouldn’t change anything. As the interest is only increasing on paper, you won’t clear the loan anyway before it wipes. So it’s throwing cash away.
This is another reason why I’m in favour of renaming student loans and calling them a graduate contribution (see my Student loans aren’t a debt – change the name blog). As moving away from framing it as a ‘debt’ would make the conceptual challenge of explaining how it really works much easier.
A horrific and extreme example
My inspiration for writing this blog came from the Ideal Home Show. A mother with her recently graduated daughter were there to see my talk. In the Q&A session afterwards, the mother told me that her daughter had been struck down with a severe disability leaving her unable to work and potentially unlikely ever to be able to work again.
They asked about student loans as they were watching the interest increase each month – and were petrified as they weren’t paying any of it off. Yet they had little cash to be able to do anything.
Worse still, apparently (and I’ve no independent confirmation) the Student Loans Company had advised them to volunteer to pay more as that would help reduce the interest.
I was steaming with anger when I heard this. If someone is never going to earn over £21,000, they will not have to repay a penny. Therefore, whatever the statement says is the size of their account, is totally irrelevant. And overpaying unless they can clear the whole amount would not reduce their costs.