Student Loans – should you repay early?

Student loans are a Government-run scheme in the UK and the most recent plan (Plan 2) has resulted in higher education in the UK being the most expensive in Europe. The following article will briefly outline the basics of student loans and what factors to consider when deciding whether overpayment is a good idea.

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What is a student loan?

The full student loan consists of two components:

  • The tuition fee loan – paid directly to the University on your behalf in 3 instalments
  • The maintenance loan – paid to the student in 3 instalments (once per term) with a means-tested grant if applicable. The loan component is repayable, whereas the grant component is not. You can choose how much of the maintenance loan you want to apply for and this may be a useful option if you can afford to, in order to reduce how much you have to repay in future.

The repayments begin in April after your course finishes and are triggered when your earnings are above the threshold (different thresholds for different Plans). You repay 9% of your net earnings (after tax and pension deductions) on a monthly basis for 30 years (Plan 2) or 25 years (Plan 1) when any outstanding balance is written off.

You do not need to repay your student loan when your gross (pre-tax and pension deducted) income falls below the relevant thresholds, unlike a regular loan.

Types of Student Loans

There are three Plans, based on when you studied, that you might be on:

Plan 1:

If you started university between 1998 and Aug 2012, you would be on Plan 1. The interest rate for Plan 1 loans is always at whichever is lowest between:

  • The RPI rate from March of the same year
  • The Bank of England base rate plus 1%.

Therefore, it is currently 1.1%

The repayment threshold for Plan 1 loans is currently £19,895/year (£1,657/month or £382/week) before tax.

You pay 9% on the amount above the threshold.

If you started studying in the 2005/06 academic year or earlier, your Plan 1 Student Loan will be written off when you turn 65. If you started university in the 2006/07 academic year or later, your Plan 1 Student Loan will be written off after 25 years.

Plan 2:

If you started university after September 2012 in England and Wales, you will be on Plan 2. 

While studying, and until April after you’ve left your course, the interest rate on your Student Loan is RPI plus 3%.

After graduating, the interest rate on your Student Loan is set at RPI plus anything from 0% – 3% depending on your earnings:

  • If you earn £27,295 or less, the interest rate is just RPI
  • If you earn over £27,295 it’s RPI plus a percentage of up to 3%. This added percentage will start low and rise in line with whatever you’re earning. It stops increasing when you start earning more than £49,130, at which point it’s capped at 3%.

The Student Loan repayment threshold for Plan 2 loans is £27,295/year (£2,274/month or £524/week) before tax. You pay 9% on the amount over £27,295.

Plan 2 loans are written off 30 years after you first become eligible to repay.

Plan 4:

This only applies to Scotland and is not administered in the rest of the UK. Any Scottish students who started university after 1998 are now on this plan, they were previously on Plan 1. The only difference is now the repayment threshold is much higher. 

Key facts about student loans

Loan StatementThis figure doesn’t really matter. You will be paying off 9% of your salary for 30 years, not the whole balance for as long as it takes. 
Threshold If you’re under the threshold, then you don’t pay your student loan.
High EarnersThe individuals who need to worry about student loans are high earners as they are most likely to actually pay off their student loans. 
Loan AmountIf you graduate with a lower amount of debt then you are more likely to pay it off before 30yrs so saving the interest is worthwhile

Should you pay off or overpay your student loan?

Key Considerations:

  • Buying a house: If you do not have a lump sum at hand to pay off some of your loans or need it for a house deposit, you will still be losing money in rent if you try to save on student loan interest 
  • RPI: As inflation increases, so will the interest rates. It’s impossible to predict the future but if you want to avoid interest hikes due to inflation then overpayment is better
  • Salary Increases: Doctors’ salaries increase, but not linearly, and it is very hard to predict the additional payments for out of hours etc. Therefore, trying to forecast payments is near impossible.  
  • Graduate Tax: Most resources suggest treating student loan repayments as a graduate tax rather than a loan. The psychological impact of having the loan weighing on you is worse than the loan itself. 

Closing remarks

Taking into account all the considerations above, there is no right or wrong answer to this question as it entirely depends on personal circumstances. If money is no object, then paying the loan off immediately would save the most interest. However, many of us are not in this situation. Early in our career, making an overpayment on our monthly repayments may not make much of a dent in the overall balance, especially as time goes on, the high-interest rate will mean the balance grows more quickly than we can pay off. Doctors are likely to be high-earners, but not until 10 years (unless you become a GP) after we graduate from medical school. This means there are around 20+ years where 9% of our salary will be a significant amount and will come close to paying off our loan – adding interest on top of this, we will end up paying back quite a lot more than what we borrowed. Conversely, we may want to prioritise other things such as buying a home or travelling, the loan repayments give us the flexibility to do this as we only ever pay 9% of our salary and only for 30 years. It comes down to how you want to look at the situation, you can choose to focus on the figure on the balance statement (which is not unreasonable but also not in our control) or you can choose to treat the repayments as a graduate tax for 30 years and focus your mind on your career and personal life.


Personal Experience by Dr Gabriela Di Scenza

This section will explore my personal experience with student loans and repayments. Being a graduate-entry medic, I knew the debt repayments would be starting as soon as I graduated. Having worked in non-graduate jobs (read: lower-paying), I had seen the paltry amounts titled ‘Student Loan’ on my payslip deducted without much concern. Interest rates on the Plan 1 Loan (pre-2012) are comparatively low (1.25% currently) and the debt would be cancelled after 25 years, I had been lulled into a false sense of security by teachers and slick university open day finance presentations. Taking on a medical degree and a Plan 2 Loan (post-2012) was a bigger undertaking. The interest rate is currently 5.6% (currently capped at 4.4%) and I knew I would have to take out considerably more than for my first degree. Reluctantly, I signed up to take out as much as I could. After all, it was my life’s goal to be a doctor and I had no other feasible way of paying tuition fees and the bulk of my living costs. 

Bearing all of this in mind, it should not have been a shock when starting F1 when I saw £90 leaving my payslip each month, then £110. Due to fluctuations in my salary, I thought it was best to clarify my repayments straight from the horse’s mouth. Student Finance England informed me this was correct and that from April 2022 I can look forward to paying 9% of my salary over the repayment threshold, making my overall monthly payment approximately £150 per month. With a net (pre-tax) salary of just over £2600, this seemed comparatively steep. After all, this is money I could be saving towards a house, a wedding or even a car. 

My combined Plan 1 and Plan 2 debt currently stands at approximately £75,000, echoing the findings of University of Birmingham researchers Ercolani et al, that the typical UK Medical Graduate will accumulate between £64,000 and £82,000 of debt under the Plan 2 Loan system, with marked gender disparity. When not factoring in maintenance loans, a male graduate will repay £57,303 over 20 years, while the average female earns less and repays £61,809 over 26 years. But when maintenance loans are added the average female repays £75,786 while the average male repays £110,644. Based on these figures, the average graduate, even at the lower end, is unlikely to repay their loans in full. 

Whilst trying to look at this more positively as a graduate tax of sorts, rather than a spiralling debt, it struck me that this is a loan that as a cohort, we have been mis-sold. When tuition fees were raised to £9,000, we were assured that disadvantaged students would be entitled to more financial aid such as bursaries during their degrees. Additionally, the less your parents earned, the more money you were entitled to in student loans. But in practice, this means that students from poorer backgrounds have larger loans than their wealthier peers and are therefore potentially less likely to pay the full sum back, even paying more than the total amount they took out, due to the interest rates applied. The current Bank of England bank rates are 0.25% and it is possible to take out a personal loan between £25,000 and £35,000 for 3.3% rep APR (1-7 years) both of which are lower than the interest rates on Plan 2 Loans. On my current salary and the size of my debt, my payments are not enough to cover the interest applied. Therefore, the debt is growing, not reducing and will accumulate interest as time goes by. Adding to the complexity, doctor’s pay tends to rise in stages, not a linear progression as in other careers and interest rates fluctuate, so it is difficult to predict how much I will be paying off over the course of my career.

Current Research- The Psychological Burden of Student Debt in the United Kingdom

A recent study from the Higher Education Policy Institute (HEPI) and the Centre for Global Higher Education (CGHE) focuses on the psychological burden of student loan debt in England for Plan 1 and Plan 2 loans. Not surprisingly, it found that students with Plan 2 Loans view their debts more negatively than their Plan 1 predecessors. It states that when policymakers are looking to plan Student Finance policy for the future, they need to consider the interest rates and the perception that the payments are ‘never-ending’. It also found the real-time effect on graduates to be contradictory to the progressive values that were advocated when Plan 2 loans were introduced. Instead graduates experience ‘emotional and psychological disturbance’ due to their debt and worries about paying it off in its entirety[1]


Case study: Medics in America 

In America, the student finance system is almost entirely private with graduates taking out vast amounts in loans to pay for their medical education. In 2021 this average was a staggering $241,600 (£178,668). There are some notable differences to UK medical student debt with the average starting salary of a ‘resident’, a US junior doctor being $58,921 (£43,085) rising every year compared with the starting salary of an F1 being £28,808 plus banding. But where significant differences can be seen is upon completion of training where a Primary Care Physician currently earns on average $214,000 (£159,687) annually whilst Specialists earnt considerably more depending on their speciality, standing them in much better stead to pay these loans in comparison to their UK counterparts.

Due to the coronavirus pandemic, US graduates have not had to make payments on federal loans (government-backed loans) since March 2020. There is currently political pressure being placed on politicians to reduce the overall burden of debt on US Graduates or cancel this altogether. 

Takeaways?

First off, as easy as it is to say, try not to panic. Student finance in the UK is almost entirely government-run, meaning bailiffs will not be approaching you for money and student loans do not adversely affect your credit rating. From my experience, they are considered as an expense when applying for a mortgage in the same way household bills and credit cards are, so when planning your financial future, they should be factored in.

Whilst the future political and economic climate may change student loans significantly, in the meantime, the best approach to take is a proactive one. Watch our videos on finance, research and judge your circumstances according to what your priorities are. If your debt is in the lower range, it may be worth paying it off as soon as possible, but evaluate if this is a sacrifice you can make, over, for example, saving for a deposit for a mortgage. Additionally, when union representatives are asking for your votes ie: BMA or HCSA raise this with them as after all this will be an important issue for the future and one that will weigh substantially on graduates for the foreseeable future. 

References

  1. Gov.uk – Student Loan – What you pay?
  2. Gov.uk – How is interest calculated in plan 2?
  3. BMJ – The lifetime cost to English students of borrowing to invest in a medical degree: a gender comparison using data from the Office for National Statistics
  4. Gov.uk – Student Finance for new fulltime students
  5. Higher Education – The determinants of student loan take-up in England
  6. Bank of England – the interest rate
  7. MoneySavingExpert – Cheap personal loans
  8. NHS Exmployers – Pay & Conditions Circular
  9. HEPI – Graduates reveal the financial and psychological burden of student loan debt
  10. Education Data – Average Medical School Debt
  11. MedEdits – Residency Salary
  12. MedScape – 2021 compensation overview
  13. MedScale – 2021 compensation overview slideshow
  14. Gov.uk reports – Federal Student Loan Debt Relief in the Context of COVID-19
  15. Gov.uk – 8 things you should know about your student loan

Resources

Written by Dr Cyra Asher & Dr Gabriela Di Scenza

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