Do I have to take out a bank loan to repay my student loan?
Taking a look at your student loan statement can be a scary undertaking. The sight of how much you owe and how much interest is being added each year may make you think something needs to be done about it. You may even be thinking about getting a bank loan to pay off your student loan.
Let me stop you there. In this article, we’ll explain how student loan repayments actually work. And once you get the hang of the system, you’ll see why a bank loan might not be such a great idea.
What student loan do you have?
First of all, there are two types of student loans in UK. The plan you are on will dictate your refund threshold as well as the amount of interest added to your balance.
You will be on plan 1 if you are:
- An English or Welsh student who started an undergraduate course anywhere in the UK before September 1, 2012.
- A Scottish or Northern Irish student who started a course on or after September 1, 1998.
If you are on Plan 1 then the payout threshold is currently when you earn £ 19,895 per year, £ 1,658 per month or £ 382 per week.
You will be on plan 2 if:
- You started your course after September 1, 2012 in England or Wales.
If you are on Plan 2, you will start paying off your student loan when you earn £ 27,295 per year, £ 2,275 per month or £ 525 per week.
For both plans, you will pay 9% of the amount you earn above the threshold. This is important, so don’t forget this.
Bank loan or student loan?
It can be tempting to liquidate your student loan. This annual statement may make you think that you have this huge and growing debt hanging over you. But in reality, this is simply not the case. Confused? Don’t be.
In order to understand why taking out a bank loan to pay off a student loan would not be a wise move, we need to understand student loan interest.
Whatever your plan, your student loan interest is in line with inflation. So there is no real cost of borrowing, because what you pay back is the rate of inflation. If you want a more detailed breakdown, check out our article on Understanding Student Loan Interest Rates.
So for Plan 1, the interest rate is the Retail Price Index (RPI) or the base rate of the Bank of England plus 1% (whichever is lower). At the time of writing, the interest rate is 1.1%.
Regarding Plan 2, your interest depends on your income:
- £ 27,295 or less: RPI (currently 2.6%)
- £ 27,296 to £ 49,130: RPI plus up to 3%
- Over £ 49,130: RPI plus 3%
Therefore, if you were to compare a bank loan directly to a student loan, you would have an average interest rate of around 7%, compared to a maximum interest rate of 5.6%.
Already, it wouldn’t make sense to get a bank loan to pay off your student debt. And that’s before we see how student loans actually work.
How do student loans work?
The nature of a student loan is that your interest rate is in line with inflation and will eventually be amortized. But also, your repayments will never exceed the 9% threshold, no matter how much you owe.
So let’s say you have a student loan of £ 20,000 and you earn £ 37,295 per year, which is £ 10,000 above the Plan 2 threshold. Your annual student loan repayment will be £ 900.
Now let’s say your student loan debt is considerably higher at £ 60,000. With a salary of £ 37,295 per year, your annual repayment will be always be £ 900. It doesn’t matter how much debt you have, it’s about how much you earn above the threshold.
You might think that having so much debt hanging over you is a problem. But the impact of having it there won’t really change unless you’re in the top 20% of graduates.
Basically, unless it’s likely you’ll be able to write off all of your debt and interest before your student loan is written off, there’s no point in overpaying.
You could work day and night to pay off a debt that will eventually be written off anyway. So it may make more sense to use that money to write off other debt or save and grow your money.
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