Cutting through noise: The truth about UK student loans

student loans

Photo by Becca Tapert on Unsplash

In 2012, the UK government raised the price of tuition from £3,000 to £9,000 per annum, and since then it’s increased to £9,250 each year.

Add maintenance loans to the mix, and students who complete a three-year degree will graduate with over £40,000 in debt; the cost is substantially greater for those who choose to study abroad for a year or do an integrated Master’s degree.

The topic of higher education and student loans is incredibly politicised, so I’m going to avoid discussing whether or not university should cost £9,000 per year or whether the existing loan system is fair.

Instead, I’m going to focus on clearing up some of the misinformation out there about how student loans work, how they are repaid and why they are different to other types of debt.

1. Student Loans Are Not Normal Debt

People often complain that student loans mean that young people start their careers severely indebted. Although this is theoretically true, student loans are not the same as other forms of debt. It cannot be recalled by the lender, nor can it make you bankrupt.

Instead, as Martin Lewis often says, student loans are often more like a graduate contribution system. Why’s that? Well, because unlike other debt, repayments are automatically deducted from payslips once a graduate earns above £25,000.

Student loan repayments look a lot like taxes and are basically deducted in the same way that National Insurance is automatically deducted from pay along with income tax. (Read on to find out more about this.)

It’s important to also appreciate that graduates are not obliged to pay back all the money the borrowed, unlike with normal debt. Student debt is written off after 30 years, so regardless of how much you still owe, you will not repay a penny after this period. It’s estimated that only 17% of graduates will repay their student loans, so don’t worry about the (eye-watering) £40,000 figure.

Lastly, unlike regular debt, student debt does not impact your credit score. A graduate with £40,000 of debt hanging over their head will not face any additional hurdles when trying to get a mortgage, for example.

2. How Interest Is Charged on Student Loans

Interest on student loans is currently charged at RPI (inflation) + 3%, which works out at roughly 6% per year. Unknown to a lot of people, interest is charged on student loans from day one, meaning that a first-year university student is charged interest from the moment they accept their first loan instalment.

At face value, it seems absurd - outrageous, even - that student loans currently carry nearly 6% interest, given that the base rate is currently 0.5%. However, interest rates are deliberately high in order to compensate for the fact that most people don’t pay them back within the 30-year period that was mentioned above. 

In reality, just 17% of people are anticipated to pay back their entire loans. (Although some may argue that this number may be especially low due to the high amount of interest being charged in the first place).  

3. How Student Loan Repayments Are Made

Graduates only start repaying their student loans once they earn over £25,000 per year. The repayment amount is calculated as 9% of all earnings above the £25,000 threshold and is automatically deducted from payslips just like tax. If a graduate earns less than £25,000, then they do not pay anything back.  

The total amount of debt that a graduate owes does not impact the amount that he or she pays because the amount they repay is calculated based on earnings. Therefore, a graduate with £40,000 of debt will repay the same amount each month as someone with just £10,000 of debt, provided they earn the same amount. 

For example, if both graduates earn £30,000, they will each pay just £37.50 each month towards paying off their student loans. However, a graduate earning £30,000 will not make repayments that are greater than the 6% interest charged on the total loan. Therefore, their total loan will actually increase despite their repayments.

In fact, a graduate needs to earn around £43,000 in order to pay off the interest on their loan and stop it from getting bigger. Given that the average UK salary is £26,000, it’s no wonder that most student debt is expected to be written off.

The Bottom Line

Well, there you have it. Student loans are expensive when you focus only on the fact that a three-year degree can often lead to a £40,000 debt.

The RPI +3% interest charged on loans is also pretty hefty. However, your repayments will only increase if your salary increases, meaning you only pay back what you can afford. Similarly, if your salary decreases, so do your loan repayments.

Overall, making the decision not to go to university because you’re worried about student debt is, in our opinion, an unwise decision. You’ll only pay back the entire £40,000 plus interest if you land yourself a very well-paying job - in which case, loan repayments may not worry you too much!

Basing the decision to go to university on whether your degree will offer you great career opportunities is probably a better course of action.