Should I Pay My Student Loan Off?
The question of whether I should use my savings to pay down my student debt is not a very unique issue. Millions of UK citizens have such debts, and there remains a very conflicted view of whether it’s worth paying it down, or whether it actually provides a financial benefit to defer payment for as long as possible.
Well the answer depends on which type of student loan you have. Pre 1997 Student loans have a higher interest rate setting rule – equal to the RPI (inflation) figure of the prior March. Post 1997 loans will be the LOWER of the previous March RPI or the Base Interest Rate + 1%. Therefore if March RPI was 4% but the base rate was just 1.5%, then pre 1997 loan holders will pay 4%, and post-1997 will pay 2.5%.
The Key Borrowing Principles.
Consider all of these borrowing principles to conclude whether you really should pay off yout student loan early:
Student Loans Are The Cheapest Form of Long Term Finance – Guaranteed (By Simple Finance Theory).
This is an important and crucial concept. Ask the average man in the street whether student loans are a cheap form of finance and you will probably get mixed responses. student loans will always be cheaper than commercial debt because the interest rate is priced at a rate so low that no bank could possibly compete. Post 1997 loans, as you’ll read below, will always cost a maximum of the Bank of England Base Rate + 1%. Traditional lenders such as RBS can only obtain financing to pay to borrowers at a rate similar to this. Therefore there is no profit margin to be had. When you consider that lenders are also exposed to the risk of defaulting, they need to charge rates several percentage points above the BoE Base Rate to make this lending activity worthwhile. This is why you will never find a cheaper source of finance than a student loan.
Cost of Borrowing versus Returns from Saving
In any business context, if you can earn more from a project (risk free) than it costs to finance it, you should go ahead with the project. In our case, this means if we are paying 2% interest on our student loan but receive 3% on a savings account, then we are actually earning a profit from putting cash in savings, rather than using it to pay off a loan. At the moment, interest rates are very low, which may weaken the attractiveness of this option, however over the long term, savings rates should be larger than your interest payments (because historically, interest rates are greater than inflation).
The Availability of Cheap Finance
Upon graduation, students often use some savings to pay down their 3.5% student loan immeadiately, with the knowledge that they have no ‘need’ for debt. These same students, 5 years on, are then forced to take mortgages for 5%. If the student had made no extra repayments, then they would be able to effectively substitute this ‘cheap’ student debt, for some expensive commercial debt. In this respect, you could imagine student loans as a ‘partial mortgage in advance’, which will reduce the future size of the actual mortgage that will eventually need to be taken out.
Student Loans Impact on your Financial Strength.
Does paying down a student loan early improve your credit rating, and ability to borrow in the future? The simple answer is; it’s hard to tell. The possession of a student loan cannot by regulation, affect ones credit score. However, the interest payments will reduce your disposable income, which will affect your score with certainty. What is safe to be said, is that students loan will affect your ability to obtain credit the least, of all forms of finance.
The Conclusion?
No size-fits-all approach could possibly be applied to this question, although MoneySavingExpert Martin Lewis states that in most cases, the answer will be no.