Dear Monzo, should I pay off my student loan early?

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Dear Monzo,

Should I bother paying off my student loan early with larger sums? Or just keep slowly chipping away?

It feels like a huge debt that I’m never going to get rid of.

– Graduate in Debt


Dear Graduate in Debt,

There’s an itchy unease to owing someone else money. So it can feel like the right thing to do is pay off anything outstanding as quickly as you possibly can.

But what many people don’t realise is that by clearing your student loan early, you could actually end up losing money! This applies if you started university after 1st September 2012, when tuition fees rocketed.

By clearing your student loan early, you could actually end up losing money!

That’s because student loans are very different to most other kinds of debt. Usually when you borrow money, the sooner you pay it back, the better. For example, it’s always a good idea to pay down debts on credit cards and payday loans before you save any money, because the interest rates you’ll pay on these debts are way higher than the ones you’ll earn on savings accounts.

Student loan debt is very different. Interest rates on student loans are notoriously high. But for the majority of graduates who started university in 2012 or later, that’s irrelevant. That’s because how much you have to pay back is tied to the amount of money you make. A lot like a tax.

Student loan debt is very different...because how much you have to pay back is tied to the amount of money you make. A lot like a tax.

Think about it like this: If you were a really loaded banker with a couple of flashy cars in the driveway, would you wake up in the middle of the night sweating about your tax bill? Probably not. Because tax is based on how much you earn, you wouldn’t fret about how to pay it. If you earned nothing, you’d pay nothing. If you earned lots, you’d have (more than) enough.

Student loans work in a similar way. You don’t have to pay anything back until you earn a certain amount. At the moment that’s just over £25,725, rising to £26,575 a year in 2020.

You then repay 9% of anything you earn above that. That means if you earn £35,725, for example, you’ll pay 9% of £10,000 (the difference between £25,725 and £35,725), or £900.

No matter how big your loan, or how much the interest grows on that outstanding loan, you’ll only ever repay 9% of what you earn over the threshold – just like a tax.

Your loan also gets wiped out completely after 30 years. So the likely (albeit slightly grim) reality is you could pay this 9% tax for 30 years after you graduate, without ever repaying the whole loan. Many people will never even clear the sum they borrowed, let alone the interest on top.

The same can’t be said for bank loans, which you owe regardless of how much you earn, or how long you’ve been trying to repay them.

No matter how big your loan, or how much the interest grows on that outstanding loan, you’ll only ever repay 9% of what you earn over the threshold – just like a tax.

It’s estimated that 83% of graduates that started uni in 2012 or later will never repay their student loan in full. So if you fall into this category (which statistically, you’re likely to) it doesn’t make sense to repay your loan faster. If you do decide to pay back even part of your loan early, you’ll end up losing money. A bit like paying too much tax.

It’s estimated that 83% of graduates that started uni in 2012 or later will never repay their student loan in full.

I recently heard Money Saving Expert Martin Lewis explain the consequences of doing this. He was approached by the parents of a young woman who dropped out of university because she was injured in an accident. She’s now disabled and unlikely to ever work. Her parents were extremely worried about the student debt she “owed,” and were keen to pay it off on her behalf. But they didn’t realise that their daughter wouldn’t need to repay any of the debt if she wasn’t working, and it’d be written off entirely after 30 years. Had they gone ahead and paid it off, they’d have lost all the money.

The exception to all this is if you earn a lot of money. The more you earn as a graduate, the more you have to repay. So if you make way more than the average wage, it does make sense to consider clearing your loan early to avoid paying onerous amounts of interest.

Martin Lewis suggests “a lot of money” in this context is people starting out with a salary of at least £40,000 or more, and getting pay rises each year in line with inflation. But this is just a guide.

Work out if you’re on track to clear your full debt within 30 years. And if you are, it might be worth overpaying to try and clear your loan quicker.

If you are in this position, you also need to be fairly confident that you’ll keep earning a high salary, and that you don’t need it for anything else (like buying a house, for example, which could save you more in the long run anyway).

On the subject of buying property, I’m often asked how student loan debts affect credit scores and mortgages. In short, they don’t. Student loans don’t appear on your credit file. And lenders won’t ‘judge’ you for being in debt.

I’m often asked how student loan debts affect credit scores and mortgages. In short, they don’t.

The only way they’re taken into account when you buy a home is when a bank will look at how much you can borrow on a mortgage.

Student loan repayments reduce how much money you have in your bank account each month (just like tax does). And the less money you have, the less you can borrow on a mortgage.

Student debt – whether or not you think it’s fair that young people have to manage it and factor it into their finances until they’re into their 50s – isn’t the sort that should freak you out.

Unless you’re a really high earner, I'd ignore your loan as much as you can. Just let it rumble on in the background, and put any savings you have towards a house, a pension, or a rainy day.

– Laura