The Finumus household is enjoying its first interaction with the student loan scheme in 30 years.
Our eldest is (hopefully) off to university in the autumn. Our youngest will be going two years later.
Just to keep things interesting, the government is completely overhauling the student loans system for the 2023 intake. Hence we get to do a little natural experiment with our finances.
We’ll skip over the debate about whether university is a good use of time and money. Our children are going, and that’s that.
The question for now is: “Should they borrow the money or not?”
Enter the student loan
Let’s first acknowledge how fortunate we are that whether or not to take the student loan is even a question.
Most families don’t have a choice. The only way their children can afford to go to university is with a loan. This makes the value-for-money calculation that much harder for them.
But our kids go to public (that is, private) school. The annual cost of their education will actually be marginally reduced once they are at university, compared to the current status quo, even if they borrow nothing.
So we can afford to support them – in terms of both fees and maintenance.
However we’re going to have them borrow the maximum amount of student loan.
Like everyone else they’ll be saddled with crippling student debt when they graduate!
Does this seem a bit mean to you?
Let’s look at the reasoning.
How the student finance system works
Students are expected to borrow money from the government’s student finance scheme to fund their university education.
They can borrow to cover all the fees (£9,250 p.a. ) and also some element of maintenance – ranging from about £4,500 p.a. to about £12,000 p.a. – depending on various complicated criteria, including family income.
(This is if you reside in England and are attending university in England. Otherwise the rules are more complicated).
Repayment works like a hypothecated, limited amount, graduate tax.
- Under the current scheme, you have to pay an additional 9% income tax over a certain threshold, until you’ve paid the loan back or until 30 years has passed. At that point the student loan is written off. Interest charged is roughly RPI+3%.
- With the new (2023) scheme, the earnings threshold is lower, the interest rate is lower (roughly RPI), and the term is 40 years.
Crucially, for us, you can also repay early with no redemption penalty.
According to the IFS, the 2023 changes will mean that far more graduates will repay their loan in full (75% vs 25%) but those students who would be paying it back in full under both systems (that is, higher earners) will benefit under the new scheme. This is because the interest rate is lower.
More lower earners, who might have escaped repayment under the old system, will be caught by the new lower earnings threshold. These people will end up worse off.
The change then is highly regressive – if you are measuring only within graduates.
If you’re thinking about the wider tax base, it’s not quite so clear – because arguably the change reduces the tax burden currently falling on those who don’t go to university.
The stated intent of the changes is to encourage students to read subjects that lead to higher-paying careers.
Any side effect of discouraging some from going at all the government doubtless sees as an extra bonus. After all, universities teach young people to think for themselves, and turn out lefty-liberal-remainer-voting ‘experts’.
But this is a finance blog not a political one.
Let’s take the system as we find it and – well – think for ourselves.
Gaming the system
Back in the halcyon days of positive real interest rates, low asset prices and cheap student debt – when your correspondent was at university – gaming the system was easy.
The student loan was only required to cover maintenance (fees were paid by the state – imagine) and the interest rate charged was very low.
Although my parents insisted that they didn’t want me to get into debt and hence paid for my maintenance, I of course borrowed the money anyway and used it to speculate in the stock market.
I could even have stuck it in the bank and come out ahead, too. (Admittedly you did have to avoid the temptation to spend it all in the union bar).
But things are more complicated under today’s shifting regime. The loan is dearer than it was for me, for a start.
However even if you can afford to sidestep the student loan altogether and just have your kids pay-as-you-go (PAYG), you might still want them to get into hock by maxing out their student loan, and then you (as a family) stash away the equivalent sum borrowed elsewhere.
To be clear, we’re suggesting that on graduation, our graduate will be in one of two positions:
Which one is best? The net positions seem identical.
However there are two reasons why you might prefer to borrow:
- Positive carry: it makes sense to take out the student loan if you can earn a low-risk post-tax return that’s higher than the interest rate on the loan.
- Loan write-off: if our young graduate isn’t ever going to have to pay the loan back, then that’s a win.
We’re not going to spend much time on the first reason. Earning a sufficiently high yet near-risk-free rate of return will be extremely difficult under the current scheme, although it might just be possible under the 2023 scheme, with its lower interest rate.
Your required rate of return also depends on your individual tax circumstances. It’ll be harder if you’re already filling up everyone’s ISAs and SIPPs to the max, for example, because your return will be taxed. You’ll have to do your own maths, based on your personal circumstances.
Borrowing also adds unnecessary complexity and leverage to the family’s affairs, so that’s a demerit.
All things considered, for us the positive carry argument doesn’t stand on its own.
It comes down to the second reason. Are my kids really going to have to pay the loan back?
Reversible decisions
As Jeff Bezos famously pointed out in his 1997 Amazon shareholder letter, it’s much easier to make reversible decisions.
The student loan can be paid back at any time. This means borrowing the money is an easily reversible decision.
At any time after graduation our family can collapse the ‘Borrow’ row in my table above into the ‘PAYG’ row. We simply take money from our savings and write a cheque to the Student Loans Company to do so.
However we can’t go the other way round. Once we’ve not-borrowed the money, there’s no going back and asking to borrow it again.
Therefore, we should borrow the money. It’s what’s known in finance parlance as a free ‘real option’:
We’d be foolish not to take it.
Little darlings
If you’re in a position to make a decision like this, you’re likely over-estimating the probability that your child will have to back the loan in full.
We know that between 75% (current scheme) and 25% (new scheme) of graduates won’t repay the loan in full.
But of course, your kids will, right?
You’re likely a high-earning university graduate yourself.
So you imagine that your children are going to have fulfilling, well-remunerated careers.
They may well do so. But they might not.
Stuff you don’t want to think about
I was fortunate enough to attend one of Britain’s most elite universities – the sort of place that churns out Prime Ministers and Fortune 500 CEOs.
At a recent gathering of some old college friends, conversation turned to the range of outcomes that our cohort of about 150 had experienced. This led me to consider whether we all would have paid back the student loan if we’d been borrowing under today’s rules back then.
In our sample there’s a large rump of successful middle-class high-earners, a few centimillionaires, and a bus driver. All of them would likely all be paying back their loans.
Then we have people who have worked their whole lives for charities on fairly low pay – mostly women. Some had a fairly short career because they decided to prioritize family. Others became artists or poets.
They likely wouldn’t be paying back their whole loan.
We also have a few who wouldn’t have had to repay any of the loan at all. The ones who suffered mental and physical health problems, addiction, family break-ups, legal problems, or just unlucky employment choices that materially impacted their ability to earn. Their careers sort of petered out before they really got going.
Finally, and I’m sorry to bring this up, but it is a reality – we have those who didn’t make it at all.
One didn’t get to graduation. Three died before they were 30: traffic accident, drowning, cancer.
I concede this is a set of anecdotes, not a representative sample. But there it is. Sometimes things don’t go to plan. It doesn’t matter how middle-class you are, how good a university you go to, or how much money you have. Nobody is immune to these possibilities.
More happily, we also had a few who permanently emigrated. They wouldn’t need to pay back their loan. (I know nowadays in theory you would, but in practice if you’re permanently emigrating then what are they gonna do about it?)
They’ll change the rules
So there you have it. As a family, you should have your children borrow the money, while you squirrel away in a savings account whatever you would have spent. Then simply decide later whether to pay it back.
You could choose to repay the loan the day they graduate or a decade later. Taking out the student loan is an easily-reversed decision that provides a fairly low-cost insurance policy against bad outcomes for your child.
Finally there’s the other side of the equation. The rules will change – probably for the worse, but possibly for the better.
The whole system could be replaced with a graduate tax, which they’d be paying anyway. This would likely incorporate some sort of forgiveness of the existing debt as part of the process.
The fact is 30-40 years is a very long time. Anything could happen. The US paused loan repayments during the pandemic. Some politicians are now advocating student loan forgiveness.
Just whatever you do, don’t let your spunky offspring splurge the borrowed money away in a future resurgence of YOLO madness.
If you enjoyed this, follow Finumus on Twitter or read his other articles for Monevator.
You and your child are about to experience an important transition – at least that initial experience shouldn’t be affected by Covid the way our daughter’s was in 2020. My best wishes for it.
Like you, we decided she should apply for all the loans she was eligible for. That was partly on the advice of the Martin Lewis website, and partly on the basis you identify of the decision that way round being reversible (providing you have the assets to pay it off of course). But the whole thing is odd, as you say it is in effect a rather complicated form of graduate tax, and you have to ask why. To me there is a benefit to the country as a whole in having a well-educated working population; without that the country wouldn’t have a presence internationally in the high tech and creative-led businesses which give us our global status, and getting those with potential educated to higher level should be completely justifiable as a government expenditure. The benefit to the individual in terms of salary-earning potential should be irrelevant since in that case a decent income tax system should ensure they pay more tax anyway.
The system also lacks transparency. As Martin Lewis continually points out, there is nowhere any clear statement that better-off parents are expected to contribute financially and how much. As I experienced when I worked on the universities side myself, a significant proportion of parents don’t contribute even though their incomes affect their children’s loan capacity. Too many students suffered from spending much of their time on part-time jobs they needed just to survive, in many cases the loan didn’t even cover rent.
Great article!
There is also the possibility that the offspring have learned from their canny parents and leave uni, maximise their savings/investments and retire early thereby taking themselves out of a long repayment period.
As a mid-lifer who has just commenced a degree ‘for fun’, I’m probably not going to be paying my loan back either due to a combination of:
a. studying agriculture
b. not living long enough
c. not having income from pensions counted towards total income (unless in self-assessment).
All agreed – but I just wonder whether this year – where we may get a 12% or more interest rate on the loan – is the one year where paying up front has a bit more going for it (although I think you either pay it all or nothing – partial payment seems the worst of all worlds as you still end up with a 9% graduate tax).
Also worth factoring in 4 year v 3 year courses – a 4 year course debt is going to be circa £60,000 for fees + maintenance – so even less chance of paying it off in 30 years than for a 3 year/£45,000 debt.
Very sensible article. I would put even less weight on the “but government can change the rules” argument against taking out the loan.
In practice, it would be political suicide to do something like extend the loan term to 40 years for existing borrowers. In the latest reforms government did exactly as much as they thought they could get away with in terms of retrospective changes – keeping the Plan 2 repayment threshold at £27,295 until April 2025 – and that’s because it’s a technical tweak that most borrowers won’t even notice.
I don’t believe a true graduate tax will ever happen because: (a) government accounting rules mean that would involve putting the entire cost of the fee/maintenance system on the national debt immediately (as opposed to ~50% for entrants this year / ~10% for entrants when the reforms kick in); and (b) government has no powers to levy taxes overseas, so it would be a huge ‘brain drain’ incentive.
Unless I missed it, you haven’t made clear what the interest on the borrowing will be. Since it’s added from day 1, and compounded, and linked to RPI, it could actually be quite substantial. Cheap borrowing this is not. What exactly are you ‘insuring’ against, and how much is that insurance really costing? (This is assuming that a decision is made to pay it off for them at some point. Otherwise, you might as well not set aside the cost of the loan. Just let them get on with it themselves. Gift them money later when it seems appropriate).
Great article. Think it’s a given the rules will change given how often they’ve changed under the current political party. In the same boat myself and have been thinking long and hard about this. The one thing I’m vexed about is the reversibility point. Almost as soon as the system came in the coalition put out for consultation that better off parents should be blocked from repaying early. I think it’s a likely outcome that a change of policy would stop early repayment without much political bad press and the recent IFS research articles on the whole loan scheme pretty much state the winners are the better off.
As an opposing view it’s not often the gov gives you an option to avoid paying around 8% higher tax for much of your working life for what is a reasonably small outlay in your early twenties. (and getting cheaper every day due to inflation)
Now that 75% of students will be paying more than the cost then it’s getting harder to treat this as a simple Martin Lewis always take the money binary decision.
@drillbit. Restricting early repayment is certainly possible, but likely we would get some notice.
@vanguardfan Yes, I’m assuming that you can earn RPI, I.e. a zero real rate on your savings. I agree that this might be slightly optimistic. The cost of this insurance is obviously the spread between the two.
An interesting article. My kids haven’t reached this stage yet, but it’s good to think ahead. As well as assuming one’s children will be successful, there’s also the danger of assuming that parents and children stay happy families, such that it makes sense to reason on the basis of “family wealth”. This is sadly not always the case. If parents take control of the loaned amount (albeit in return for providing equivalent maintenance), this then gives them a significant future hold over their offspring, which could be detrimental relationally. Even without that, it’s important to consider the psychological impact on new graduates of starting life with a mountain of debt; some may cope fine; others may find it debilitating; still others may be encouraged to take on lots more less-sensible borrowing. I’m far from convinced I’ll want to saddle my children/family with this for the marginal benefit of a possible loan write-off in 30 years’ time (and that at the expense of the nation’s non-graduates…).
@Tim, I agree there are a lot of issues for families. Going to university is the real test of how your children have acquired good values, and picked up the necessary resilience. If all goes well it will be a time when they mature socially as well as intellectually.
One factor for us is that we didn’t want our daughter to feel she had any special privilege over other students, which isn’t going to be helpful in navigating a new situation. She has loans like everyone else, with top-up (in practice we pay her rent) to the maximum maintenance loan. As @Finimus points out we can pay off the loans later if desirable. We hadn’t thought of the “insurance” aspect, but I can see that you can think of it that way.
Although I’ve never worked out the maths associated with this, I take a very simple approach. As my wife and I both went to university prior to the era of student loans, I don’t wish either of my two kids, aged 26 and 30 now, to suffer the burden of paying the loans back. So at the end of every year, I simply reimburse (gift) them the total they’ve repaid. I can afford to do this, and it removes the burden of repayment from their younger shoulders.
@Finumus – the interest rate while at university is RPI plus 3%! (Not sure how that changes post 2023). And then tiered up to RPI plus 3% depending on earnings -that flattens post 2023 iirc.
Our kids have funds that they can use to support themselves through university. Although I fully understand Martin Lewis’ arguments, which will make sense for most, I think if they can avoid embroilment with the SLC so much the better. I get Tim’s argument about having ‘the same experience as the majority’ but, they’ve done state school, and I know at uni they meet people with a whole range of different set ups/leg ups (and not). I’d be very surprised if most of the privately educated kids (Finumus’ offspring excepted of course) aren’t getting quite a lot of help, including for some, having fees paid. The funds mine can access give them comparable income to a full maintenance grant, which is not so much that holiday jobs aren’t worthwhile. Personally, I think they learn more from taking responsibility for their own finances, rather than depending on future handouts conditional on ‘good behaviour’.
Whilst the loan payback provides a reversible option it does so at a considerable premium. Assuming payback at the end of the degree, the capital borrowed is compounding interest at RPI + 3% from the very beginning of the course. The interest gained on the money not used on PAYG as offset is likely negligible.
Other factors worth considering are:
– psychological: the burden of carrying the “debt” for the next 30- 40 years (I realise it is really a form of graduate tax but I believe it is still taken into consideration for mortgage loans etc)
– risk of government rule changes over 30/40 year period with retrospective impact or selling off loan book to third parties whilst enabling them, as a sweetner, to make retrospective changes (maybe a small chance but a long duration risk)
– IHT planning: depending on financial circumstances, it potentially offers a mechanism to defray inheritance tax.
– Investing in your children’s human capital. I didn’t have any post graduation debt many years ago and would like to have my children in the same position – a good degree, from a good university and no debt. Then they take (or don’t take) the opportunities that come their way or that they create.
I take the point that you don’t know what the future holds, per the article, but I think you have to assume on the balance of probabilities that (i) if your children graduate from good universities with good degrees that they will be financially successful (ii) they will live to at least 3 score years and 10 i.e. beyond the term of the loan.
@Vanguardfan
New entrants to HE from 1st August 2023 onwards:
* RPI+0% interest in- and post-study
* 40-year term
* £25k repayment threshold, rising with RPI from April 2027 onwards
Existing post-2012 borrowers (including those starting this autumn)
*RPI+3% in-study interest, RPI +0-3% variable post-study depending on earnings
*30-year term
*£27,295 repayment threshold, now frozen until April 2025 when it will increase annually by RPI (previously it increased annually by average earnings).
Why is it, when for almost every other purpose the government has claimed that RPI poorly represents inflation and replaced it by CPI, that student loan rates are still benchmarked against RPI?
@Jonathan B
(at risk of answering a rhetorical question to which everyone including you knows the answer) for the obvious if hypocritical/Machiavellian reason – RPI is almost always higher than CPI. Pay out CPI, take in RPI, pocket the difference whilst maintaining everything is “inflation-linked”.
@ Finumus – possible typo, should be “pay back”?
“….. probability that your child will have to back [sic] the loan in full.”
@Jonathan B & @Student Grant:
A memorable phrase that was coined to describe this type of behaviour by HMG was “inflation shopping”!
P.S. @SG are you a fan of Viz by any chance?
@Al Cam
Glad you picked up the reference!
@Jonathan. Remember that RPI and CPIH will be aligned in Feb 2030. RPI will still exist but it will be calculated in exactly the same way as CPIH, effectively merging the two.
Changing the inflation metric has a rather large impact across a number of areas. While students may take a small hit for the next 8 years or so, an investor holding a 50-year index linked Gilt will suffer for 42 remaining years after 2030 with no compensation. Those with pensions linked to RPI will also get less etc. These changes need long lead times.
So the last Finimus post was on the subject of crypto and stablecoins… which have proved anything but stable just over three months down the road…
https://monevator.com/defi-down-the-decentralized-finance-rabbit-hole/
This is personal fave: “In my experience you can make fairly low risk returns of 10-30% per annum in DeFi, at least at the moment.”
@neverland
look up mr goxx, he is now dead but was a hamster that traded crypto live streamed. He was programmed to buy if he ran down one tube, sell if he ran down another, with almost random buy/sell amounts within his budget range and almost random buy/sell decisions within coins. He was up 40% at one point and think he died at up nearly 20%. If a random hamster making random trades being up 30%+ is not a warning sign I don’t know what is. He got out though (by dying) and did not have his owners life savings at risk (his owner was a scientist unsurprisingly, the whole project was just for fun).
Regarding university costs. I graduated with undergrad, PhD and never had to pay tuition (but I won/earned funding for my PhD through a private funded scheme so that was not ‘on the state’). Since then my employer also paid for further postgrad studies. I now pay tuition fees myself for a further degree while working. There is something to be said for working while doing a degree if you can find a field that allows it while effectively doing a related job. I personally think too many people are doing undesirable degrees as their first degrees. This leads to my overall advice to most school age children – think seriously about your FIRST degree choice. You have a multi decade career to do additional subjects of interest once you are earning, and in my experience, employers hold strong positive views of personal study in your own time once you have an established skill set and career. Choices do matter a lot less for those with wealthy parents/support behind them, but for those who need to factor affordability into choices, I hope this advice helps at least one person, and if lack of wealth is a factor in not going to university on leaving school, the Open University remains a great choice once you have a minimal career established. Doing a degree part time also means the annual fees obviously are not ‘full time’ student amounts. Degree level learning is not just for school leavers these days and the choice for school leavers is not binary ‘university or no university?’. Indeed, many employers love to help fund part time degree studies for good staff – it adds a huge retention factor for good employees and benefits everyone.
The IFS has issued a further report in April: https://ifs.org.uk/uploads/BN341-Student-loans-reform-is-a-leap-into-the-unknown.pdf
It doesn’t give a specific figure for how the recent changes to the post-2012 scheme will have affected the proportion of students who will end up having their loan written off, but from what I can tell it is a lot lower than 75%. My best guess is that even graduates on median earnings will repay in full, so it is no longer the case that the only ones who repay in full are the kids who are headed for a career as a city lawyer or accountant, investment banker, hedge fund manager, etc.
On the emigration point, I think that because it is a loan they do have a lot of scope to make you keep on paying. The payment threshold is adjusted to reflect the cost of living in the country where you have moved to.
Taking out a loan linked to RPI under government rules is certainly for the brave. Whilst the new rules on interest are better the current ones are terrible. Students graduate with the interest applied from the start so 45k becomes 50k plus before you are earning. Then interest on the loan compounds for the next 40 odd years and probably till retirement. The govt has little reason to make things better for students as they are the red top elite. My advice pay for your children if you can it’s a nice thing to be debt free at the start and hopefully they make a choice of career on what they enjoy rather than being worried about debt. If you don’t pay it now then you will probably need to give it away at some point. A loan at RPI plus is as I said brave when dealing with a bank but with the govt controlling the rules it’s extremely brave imho.
hmmm, so both miner kids going to have student loan debt, their choice of career mean they should get over £40kpa.
We(mrs+i) are planning on leaving them ££ inheritance, so that’s means in theory indirectly we are potentially going to pay off their student loans. So that may mean if we want to leave the kids the greatest amount when we both kick the bucket we are best paying off their loans for them before they have chance to accrue interest?
@Miner – loan repayments are based on income not capital so inheritance doesn’t affect it. It does then give them the choice whether they want to use the capital to pay off loans (which as we know only makes sense if you are in the top 25% or so of earners) or use for something else (investment, house purchase, etc). Also depends how long you are planning on being around! I suppose if you are going to pay off their loans for them (or pre-pay) needs to be done more than 7 years before your inheritance is assessed.
@Pinkney “it’s a nice thing to be debt free” – but as we are all in debt early in our lives surely it is just choosing what debt you have? If you have £60K to pay your (4 year course) kid, why not give that to them so they can buy a house – with £60k less mortgage and better interest rate? And avoid them having to save up for several years for a house deposit and then ending up having to spend more on the house and getting even more debt that way? Furthermore, mortgage debt always needs to be paid off whereas student debt usually doesn’t – why choose former over latter? I think what people forget is opportunity cost – what else might you do with that money if you don’t pay student debt up front.
@Ivan
good point – but things will become clearer over the next few years and the good thing is that you always have an out – paying off loan – if the projections e.g. based on static income thresholds move against you.
@SG, if one pays off the student loan while they are still in full-time education, then that “gift” is not subject to IHT. Doing so would then reduce the estate’s IHT tax bill by 40% of the loan payment value (increased for investment growth).
@StudentGrant must say i loved viz as a student. I can only say we all have different views and for me i like being able to say my kids had the same start as i did (with my lovely grant). Starting life as a taxpayer with no debt gives them a sense of freedom. Having a mortgage early in life is not the same it drives a certain mindset. We each have our own way of solving problems and trusting the govt to not screw my offspring over is a risk i would prefer to minimise if i can..