Q&A 91 – Should I Repay My Student Loan?

Question 91

Tamzin asks: “I’ve been left some money by my late Grandfather and I’m trying to work out whether I should pay down my student loan. What do you think?”

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Q&A 91 – Should I Repay My Student Loan? – Shownotes

Tamzin asks:

My grandfather passed away at the ripe old age of 94 a few months ago. I’ve inherited from him enough money to pay off my student debt, about £50,000.

I know this would be a sensible thing to do, but given the advantageous way student debt repayment is managed, I’m not sure if it is the best course. Also, this is the most money I’ve ever seen in one place.

For clarity, I only pay back 9% of my earnings above £21,000. So if I go into a graduate job at £25,000 per year, I would only pay back £360 debt.

However, the debt increases with “Inflation plus up to 3%”, so I’m not sure at all which method is better.

 

 

Student Loan Rules

You are right to mention that you only pay back 9% of your earnings above £21,000. You are also right to note that the interest rate on student loans (for post 2012 loans) is between RPI (if you earn less than £21,000) rising slowly up to RPI + 3% if you earn over £41,000.

Therefore, your decision to repay will depend on a couple of things:

  1. The current RPI
  2. The return you can earn on your money

It will only be beneficial repaying this loan is you either have no other debts with higher interest, or you think you cannot earn more than the interest rate elsewhere. For 99% of people, both of these will not be true.

 

Comparison To Other Debts – Mortgage

Let’s start with other debts, as this is currently the toughest. Normally, people buy houses to live in. When they do, they take out a mortgage. Mortgage rates are currently at the lowest rates in history. Currently , if you took out a mortgage, you would probably have an interest rate of around 2-3%. Therefore, with RPI currently at 1.3% per annum, your student loan would be cheaper than this if you are earning £21,000 or less, more expensive if you are earning £41,000 or more, and tight if you are in the range between.

In this comparison, it’s often tough to pick a winner, but remember that the student loan repayment terms are very favourable, which makes them better if something disastrous occurred. For example, if you lost your job, you wouldn’t have to make repayments against your student loan. However, if you had a mortgage, you would still need to make your mortgage repayment.

Therefore, based on this alone, I’d usually encourage people not to repay their student loans if they intend to take out a mortgage.

 

What Could You Earn Elsewhere?

However, the main decider for me comes with “what you could earn elsewhere”. As long as you can earn an interest rate (after tax) greater than the RPI + % that you are paying on your student loan, you are effectively in a position of arbitrage where you are earning more on your investments than you are repaying on your debt.

With savings rates and current account rates currently as they are, you can earn guaranteed returns of higher than your debt repayment amounts. If you extend this to investing in higher risk assets (such as stocks & shares) then your returns will be even higher.

So, as it stands, I would not repay the student loans with your grandfather’s inheritance. However, this decision may change in the future depending on RPI rates, savings/investing rates and any other changes to student loans enforced by government policy.

 

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4 thoughts on “Q&A 91 – Should I Repay My Student Loan?

  1. Dear Moneystepper. Thanks for all the work you do. Love the site and podcast. My question is: I’ve inherited 25k and plan to keep 10k as a cash buffer and invest the other 15k in ETFs/tracker funds that track the FTSE 100 and/or 250. I’m British but live overseas and am registered as non-resident. I already buy ETFs off the LSE with a brokerage based in Luxembourg. If I transfer the money from my UK bank account to my Luxembourg brokerage am I eligible for tax or will it raise suspicions? Luxembourg is free of capital gains tax, as is the country I reside in. Regards Simon

    • Hi Simon,

      I believe that as a non-resident you will not be subject to capital gains on these investments, but will instead be taxed in the country in which you are resident.

      However, non-resident tax is a complex issue and I would recommend that you consult either with the tax authorities in your resident country, or with an international tax expert.

  2. Another (more contentious) question. Which is better, shares or property? My brother and I have each inherited 25,000 pounds. One idea is to invest the money in a buy to let property. The other is to invest it in ETFs or tracker index funds that track the FTSE 100, S&P 500 or an international stock index. I already have a mortgage free rental property but otherwise no real other savings. I would view either investment for at least a twenty year period which is when I plan to retire. Supposedly shares have historically outperformed property? Is this likely to continue? My reservations with property include the new stamp duty, likelihood of rising interest rates, high maintenance costs and generally unattractive yields right now. Have I already missed the BTL boom party already?

    • Simon – thanks for your question. Firstly, may I recommend the following article:

      http://moneystepper.com/investing/should-i-invest-in-property-or-shares/

      The conclusion here is that generally the highest reward investment (with the highest risk) is property over shares. However, recent changes to stamp duty, taxes on property income and apital gains tax changes as a result of the last budget makes the case for shares over property a little stronger.

      Historically, the capital returns of shares are a little higher than property, but when you take income into account as well, property probably just beats shares.

      The big difference, though, is leverage. Returns can be multiplied through lending through mortgages, which (for me) means that the returns obtained through property are still higher than shares, despite government policy tightening that gap.

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