If your child or grandchild is planning to head off to further education straight from school, they are not alone.
The latest figures show that going to university is a more popular choice than ever. The Guardian reports that, according to the UCAS university admissions service, 320,000 sixth formers applied for 2022 university places by January’s deadline, up from 306,000 in 2021.
The appetite for higher education remains undimmed, despite the increasing amount of debt that many students face when they graduate. Official government statistics show that the average debt among the cohort of borrowers who finished their courses in 2020 was £45,000.
You may have recently read about changes to student loans, in terms of how the interest is calculated and when graduates will have to repay. Read on to find out more, and for some useful guidance concerning how you might best support your child or grandchild through their further education.
Student loan interest set to exceed 10% in some cases
Research from the Institute for Fiscal Studies (IFS) has revealed that, without government intervention, graduates are in for a “roller coaster ride” over the next few years when it comes to the interest charged on their student loans.
The recent rise in inflation means that the maximum interest rate, which is charged to current students and graduates earning more than £49,130, will rise from its current level of 4.5% to a staggering 12% for half a year unless policy changes.
The interest rates for low earners will rise from 1.5% to 9%. This is because, depending on a graduate’s earnings, the interest rate charged is between the rate of RPI inflation and the rate of RPI inflation plus 3%.
As the chart below shows, with a typical debt of around £50,000, a high-earning recent graduate would incur around £3,000 additional interest over six months.
Source: the Telegraph
The IFS say that the maximum student loan interest rate is then likely to fall to around 7% in March 2023 and fluctuate between 7% and 9% for a year and a half. In September 2024, it is then predicted to fall to around 0% before rising again to around 5% in March 2025.
The IFS say: “These wild swings in interest rates will arise from the combination of high inflation and an interest rate cap that takes half a year to come into operation.”
Students set to pay back loans over a longer term
In addition to a steep rise in interest rates, recently announced Treasury reforms mean that students in England will have to pay back university loans over 40 years instead of 30.
This will result in the number of students expected to pay back their loan in full doubling from under a quarter (23%) to more than half (52%).
Martin Lewis, founder of MoneySavingExpert.com, warned that most graduates would pay thousands of pounds more for their degrees over their lifetime than they do now, calling it “effectively a lifelong graduate tax for most”.
Graduates will also be asked to start paying off their debt sooner after the government confirmed the repayment threshold will be cut from £27,295 to £25,000 for new borrowers starting courses from September 2023.
Why repaying students loans for a child/grandchild isn’t always the best idea
If you want to help your child or grandchild through further education, you may be considering paying back some or all their student debt.
However, it’s worth considering this warning from the IFS:
“Current borrowers may spend large sums on paying back their student loans early to avoid sky-high interest rates, unaware that they will be compensated by lower interest rates later or even that their loans will be written off with no adverse consequences after 30 years.”
It’s worth remembering that, even according to official estimates, only around half of all graduates are expected to repay their student debts in full. For example, all debts are wiped after 30 years, on death, or if a graduate becomes permanently unfit to work.
In addition, students don’t repay unless they are earning over a certain amount (£27,295 in the 2022/23 tax year). Then, they only pay a percentage of their income (currently 9%) above this threshold.
So, any student earning below the threshold (or not earning at all, for example if they are raising a family or undertaking voluntary work) won’t pay anything back. Students above the threshold only pay a small amount.
Here’s an example.
Let’s use the scenario of a £45,000 student loan and assume your child or grandchild started their course on or after 1 September 2012. If they get a job paying £35,000 a year after graduation, they will repay 9% of £7,705 each year.
This is the difference between their earnings and the threshold income level at which repayments become applicable.
Assuming nothing changes, this means they will repay £693.45 a year, or around £20,800 after 30 years, resulting in the outstanding £24,200 being written off.
While this simple example does not consider salary increases and the government’s planned reduction to the threshold at which repayments begin, they highlight an important point. If you repay the loan, you could pay back tens of thousands of pounds that may never become due.
So, in this instance, there may be better ways of you passing your wealth to the next generation. Options might include:
- Repaying any high interest debt, such as credit cards or loans
- Helping your child or grandchild onto the property ladder, by gifting/loaning a deposit or assisting with their mortgage
- Helping them to start a new business venture
- Investing the money. As student loan interest rate is linked to inflation (with a lag), if you can find ways of investing your capital that outstrip inflation then it’s likely you’ll earn more on your cash then the interest you’d pay on the student loan anyway.
It may be safer to wait
For many who graduate from university and subsequently earn low to moderate salaries, it could be a waste of money to pay upfront. However, for those on high salaries and with the prospect of steep pay increases, it would make sense financially to pay upfront.
It’s impossible to tell what the future may hold and for many who end up in high paying roles, they might decide to change their line of work or become a full-time parent instead.
With that in mind, it could make sense to adopt a wait and see approach to find out what their prospects are after university.
Get in touch
If you are considering gifting money to your child or grandchild, we can help you understand your options. For the reasons above, there may be more sensible options than paying of student debt, so talk to us before you make any decisions.
Additionally, if you are considering saving for university fees for your child or grandchild, we can help put planning at the forefront of the discussion and discuss the most efficient route to take.