Should you pay off your student loan early?

THE class of 2023 are fast approaching the end of their degree courses. At the top of their to do list will be a summer holiday free of deadlines and then maybe an attempt at securing their first graduate job. Less likely to make that list will be chipping away at the outstanding balance on their student loan.

And you know what? That’s OK. In the UK, the student loan is more of a graduate tax, rather than a ‘proper loan’. If a graduate is earning over a certain amount of money, student loan repayments are automatically deducted from their salary.

The question is should a graduate contribute an extra amount to pay it off? Well, it all depends on how much the outstanding balance is. 

For example, if it’s a smaller balance, paying it off may make sense as higher interest rates will cause it to increase. If the balance is larger, contributing extra money may not make that much of a difference.

Some may want to consider using that money elsewhere - let’s say regularly investing in a Stocks and Shares ISA and/or a SIPP. Ultimately, it’s up to the individual. 

How much does a graduate pay back?

The amount a graduate pays back is dependent on what plan they are on and the salary they earn. 

Graduates on Plans 1, 2, 4 or 5 will repay 9% of their income if they are over the threshold, while graduates on a Postgraduate Loan plan will pay just 6% of their income over the threshold¹.
 

Source: Gov.uk, May 2023

The average debt among the class of 2021/2022 stands at £45,800². The government expects that only around 20% of full-time undergraduates starting in 2021/22 would actually repay the loan in full.

And when you consider the fact that the average graduate salary is just over £24,000 - well, it may take some time for graduates to even start paying anything back. 

Even those on above average graduate salaries will only pay a small sum each month. It won’t be nearly as noticeable, as let’s say, income tax or National Insurance. 

Since interest is added to the loan, the outstanding balance will inevitably increase. Student loan interest rates are usually based on the RPI rate of inflation.³ While studying, until the April following graduation, graduates are charged RPI + 3%.

How can young people create a firm financial foundation?

Life is certainly not easy for young people right now. There’s the ongoing cost-of-living crisis to contend with, high inflation and soaring property prices, so making steps toward financial security has never been more important. 

That doesn’t necessarily mean sucking the joy out of life - they can still build a secure financial net and have fun. 

Here are two steps they can consider:

1. Create a rainy-day fund which is around 3 to 6 months’ worth of a monthly salary to give their finances a firm financial foundation. Create a fun fund too - a pot dedicated for travelling or hobbies. 
2. Set up a regular savings plan and contribute to a Stocks and Shares ISA or to a Self-Invested Personal Pension (SIPP). 
   
   That may feel daunting for those fresh out of uni. Researching stocks may not be everyone’s cup of tea, so a fund may well be a good way in. It will allow exposure to the stock market and will be diversified - an important pillar of investing.  
   
   A tracker fund is a cheap way into the stock market too. Check out 4 tracker fund ideas from our Select 50.

A graduate’s first salary may well make them feel on top of the world. Blowing the cash is easy but ensuring that hard-earned money brings value in the future does pay off.

Sources

¹ GOV.UK, 11 May 2023
² UK Parliament, 2 December 2022
³ Money Saving Expert, 6 April 2023 

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