Is it worth paying off your student loan early?

Many of those going to university this month will find themselves paying off their student loan for longer, paying more interest over that time and facing the ‘graduate tax’ for longer than previous graduates. The loan system changed last year, meaning that today’s university-goers will be on Plan 5 loans, which don’t get wiped out until 40 years after students have graduated, have a lower threshold where people start repaying the debt, but have a lowered interest rate on the loan.

But the lower interest rate only benefits those who are going to pay off their debt in full, as they’ll be charged less interest before they wipe out the debt. For huge swathes of people, the lower repayment threshold and extra decade of repayments will add thousands to the cost of their student debt.

Calculating your total student debt

Anyone in the fortunate position of weighing up whether to take out a loan or use family money (or their own cash) to pay their way at university instead will have a difficult decision ahead of them. It’s difficult work out whether you’re better off paying your own way at the start of university or repaying your loan when you graduate (either in big chunks or gradually).

It all depends on a few factors:

• Your starting salary after uni
• How much of a pay rise you see over your career
• Any career breaks you take
• Whether you work part time at any point
• What future governments do with the interest rate you pay on the debt and the threshold for repayments

Frustratingly for graduates, they can’t look into the future to see what their earnings will be and whether it’s worth repaying the debt early. However, if you know that you’re going to be a high-earner, then paying off the loan when you graduate could save tens of thousands of pounds in interest charges. For Plan 5 loans, a starting salary of around £30,000 that gradually increases over the next 40 years, is the tipping point where you’ll end up repaying marginally less than you borrowed. That means for any salaries higher than this you’ll pay off more than you initially borrowed.

Anyone who never earns more than the repayment threshold, either due to low salary for their entire career or working part time, will never make a loan repayment and so won’t be affected by the recent changes in the system – although the lower repayment threshold will mean fewer people fall into this category. However, the big bulk of middle earners who will never pay off the debt will face a lot more in repayments over their lifetimes – leading some to question whether the university degree is worth it.

What about older student loans?

Those going into their third year, as well as graduates who have finished university but have an outstanding loan, will be subject to the old student loan system.

For most this will mean they’re also paying an effective 9% tax on earnings. But repayments begin at a different threshold, currently set at £27,295 on Plan 2 loans for those who started their course between 2012 and 2022. Plan 2 loans also charge interest at the RPI measure of inflation plus 3% so the rate of interest is considerable, although the loan is written off after 30 years. The higher interest rate means there’s an added incentive to clear the loan quickly, although on the other hand the shorter term means the debt is less of a burden on those who never repay the full amount.

Those on Plan 2 loans also need to consider whether future pay rises mean it’s worth paying off the loan sooner. Those who have been in work longer probably have a clearer idea of where their career may take them, giving them a better grasp on when they might wipe the debt out through salary deductions. That information makes it easier to weigh up the pros and cons of paying off a student loan early.

If you started university in 2011 or earlier then you’re likely to be on the Plan 1 loan. Most people will have a smaller balance thanks to cheaper tuition fees and lower rates of interest linked to the Bank of England base rate. If you still have a Plan 1 balance outstanding, then it’s worth exploring your options, although the rate of interest is less punishing and you may already be close to clearing the debt anyway through your payslip deductions.

Student loan repayment top takeaways

It’s worth ensuring that you keep up to date with the Student Loans Company and make sure they have the right address for you. Once your loan is close to being repaid they’ll write to you outlining your options. It’s important not to ignore this letter otherwise you could inadvertently overpay via deductions from your payslip.

How much you could repay on a Plan 5 loan:

Based on £50,000 of student loan debt. Source: AJ Bell. Assumptions: Assumes RPI inflation of 3%, and that the repayment threshold rises by 3% a year. Assumes the graduate's salary increases by 3% a year, that they take no career breaks or early-retirement.