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Student loan dilemma: when should you make early repayments?

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If you are earning £27,500 plus – it could be worth paying back your student loan early. Here’s why…

Anyone who has taken out a student loan will face a dilemma at some point in their working life: pay off the loan as quickly as possible or simply pay back the minimum amount each year.

According to the Institute for Fiscal Studies, the average student finishes university with £50,000 of debt. With this in mind, investment platform AJ Bell has found that a starting salary of £27,500 represents the break-even point where the amount an individual will repay over 30 years is equal to the amount they borrowed.

Over this period, they will have paid off just more than they borrowed at £50,249. Thanks to the interest on the loan they will still have £150,126 left to pay after 30 years, which would be wiped out.

Under the current rules, an individual stops owing money once they have cleared the debt or when 30 years have passed from the April that followed their graduation.

Those on a starting salary between £25,000 and £27,500 will ultimately end up repaying less over 30 years than they originally borrowed, according to AJ Bell.

As the table below shows, someone starting on £25,000 would pay off £39,545 of their loan, but interest will mean that the loan debt grows to £155,149. However, over the 30-year period they will have paid off less than their original loan amount, so it wouldn’t make sense for them to pay off the loan early.

Those earning under the £25,000 mark won’t end up repaying a penny of their loan, according to AJ Bell.

High earners penalised

Meanwhile, higher earners could be penalised if they simply opt to pay back the minimum amount over 30 years. A graduate on a starting salary of £45,000 could end up paying back more than £125,000 over 30 years.

This is because they could ultimately see their salary rise to £106,045 after 30 years and would mean they are paying the highest level of interest. As a result, the total loan outstanding would rise during the first 15 years of their employed life, as the interest accumulated each year would be more than their annual loan payments.

After 30 years they would have paid £125,180 in loan repayments, but their debt left to pay would still be £30,783. This would be wiped out because they have paid off far more than they borrowed – £75,180 to be exact.

How the figures work

In the table below, AJ Bell outlines how it came to these conclusions. The figures are based on £50,000 of student debt and assume a 3% salary rise each year.

Starting salary Total loan repayments made after 30 years Loan amount outstanding Difference between original loan and amount paid off
£25,000 £39,544.69 £155,148.63 £10,455.31
£27,500 £50,249.15 £150,125.97 -£249.15
£35,000 £82,362.56 £114,952.59 -£32,362.56
£45,000 £125,180.43 £30,783.03 -£75,180.43

Source: AJ Bell

“There’s no easy answer or calculation you can do to work out whether you’d be better off repaying your student loan with a lump sum once you graduate – or indeed not taking one out in the first place – or whether you’re better off just making the repayments until it’s wiped out after 30 years,” explained Laura Suter, personal finance analyst at AJ Bell.

She noted that it is impossible for most graduates to accurately predict what they will earn in the future, how fast their salary will rise and whether they will take any career breaks. This makes it tricky to work out if they will be better off paying off the loan.

“The other unpredictable factor to student loans is that you are at the mercy of changing government policy. The 30-year lifetime of the loan is a long period and future governments might decide to change the interest rates charged or the threshold at which you start to repay, either moving in your favour or against you.

“They might also decide to extend the 30 years – or indeed make it shorter and wipe out the loan sooner,” she added.