I haven’t written a single blog post in 2021 and I’ll explain why in a future post, in the meantime, I need to offload this issue that’s been gnawing at me for a couple of weeks.
Now, I disagree with Martin Lewis (the founder of moneysavingexpert.com) on many issues related to debt but on no issue are we more at logger heads than on student loans!
Martin Lewis is of the view that UK student loans are not really loans but a form of tax, a graduate tax, in his view…his reasons for thinking this way are based on the way student loans are currently structured:
This is how it works, if one takes out student loans over the course of say, a 3-year degree and ultimately graduate with a balance of £50,000 in student debt (for argument’s sake) – it is possible that you may never have to pay this back if you are a low earner all your life.
This is because student loan repayments currently only need to be repaid when you earn £27,295 or more and even then, the repayment is structured such that you only repay at a rate of 9% over that threshold.
So, if you earn £30,000 a year, your student loan repayment is:
(30,000 – 27,295) x 9%
= 2,705 x 9%
= 243.45 or c. £20.30 per month
Even if you were on a £60,000 per annum salary the annual repayment would only be £2,945 or £245 a month.
Presented this way, it does look like a problem not really worth worrying about BUT viewing the student loan as a tax ignores the following critical issues:
1. UK student loans are not interest free
Unlike in New Zealand where student loans are fully interest free, in the UK you start accruing interest as soon as you take the loan out – they don’t even let you graduate first. If it was interest free and the government was solid in its stance on that, I would see where Michael Lewis is coming from but it isn’t.
Student loan interest rates used to be low (c.1%) but are now two to three times higher than mortgage rates having ranged from 4% to 6.6% (currently the best 5-year fixed interest rates on mortgages are just sub-1%).
2. The repayment threshold can change, so: caveat emptor
The repayment threshold can change…and a reduction in that threshold to £23,000 is believed to be in the government’s near-term plans. What this would mean is that many more people would be captured by loan repayments, after all, who goes to university to earn less than £23k, right? The median starting salary for graduates in 2021 is c.£30,000 (Highfliers.co.uk). Indeed, I would hope that all graduates can hope to earn in excess of £27k (the current threshold for student loan repayments) within a few years of graduating.
So, the person on a salary of £30k/year goes from repaying £20.30 per month to £52.50 (that’s £630 per year) and this is really quite substantial at that wage when you’re likely also saving to buy a home.
The person on £60k/year goes from repaying £245 per month to £277.50 (that’s £3,330 per year)
Basically, everyone already captured by the threshold pays an extra £32.50/month or £390/year.
3. Student loans might not be forgiven in the future
Currently, after 30 years the loan is forgiven but that could change any time, the government could increase that to 35 years, 40 years or even decide that student loans are never forgiven and any debts owed need to be deducted from the deceased estate. I hope it never comes to this but most other loans aren’t forgiven on death so if the government were cash strapped they could make a case for this.
If you think this is far-fetched, don't - this is how it already works in America.
4. Student loans reduce the rate at which you can save, invest and jump onto the property ladder
Finally, this is not a graduate tax because you do not pay it as result of having graduated. You only pay it if you have availed yourself of a student loan. Those graduates that graduate without student loans are able to save and invest at a faster rate including getting onto the property ladder faster.
If the graduate on £30k per annum saved £20/month into an index fund growing at 7% gross per annum they would have c.£24,500 in investment value in 30 years’ time, or £45,600 at a growth rate of 10% gross which is the actual historical growth rate of the stock market.
And that £60k per annum highflyer? Well, if they saved £245/month into an index fund growing at 7% gross per annum they would have just shy of £301k in investment value in 30 years’ time, or almost £560k at a growth rate of 10% gross – that’s over half a million pounds. Note that, in reality, this person would have paid the student loan off after 21 years but I have used 30 years to compare to the previous example. At 21 years the figures are £141k (at 7%) and £211k (at 10%) respectively – that extra 9 years of saving and compounding really adds up.
Not having a student loan impacts your ability to accumulate wealth. It could make a big difference to how soon you can get on the property ladder.
In the ideal world, student loans wouldn’t exist and everyone could get a tertiary education for free. However, student loans do exist and I think it is helpful to view them as loans and to either avoid them or use them wisely. For instance, I had friends put the full value of their student loan into an ISA while their parents cash flowed their university fees – now that was smart and was one way to buy a home sooner.
Some people choose to work hard during holidays to cover their living costs.
Our own strategy was to plan far in advance. We saved £4k per annum per child until their 5th birthday (and in the first few years this was at the expense of saving for our own retirement) and that £20k is left to grow until it’s needed for university. Our almost 7 year old’s £20k is now worth c.£32k and our 4.5 year old’s £20k is now worth c.£25k – we managed to get to £20k sooner for her and that’s now released us to focus on our own savings. We, of course, have no idea how student fees will evolve over the next decade or so but we hope that this strategy will at least make a huge dent to the cost.
See my post: Q&A: How can I save and invest for my children?
Heather on Wealth
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