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?”
Q&A 91 – Should I Repay My Student Loan? – Shownotes
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:
- The current RPI
- 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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