Making extra payments on your student loans can seem like an obviously good idea. But in fact, for most people using your spare cash to repay your student loan early is not a good plan.
This page will walk you through a checklist:
Understand: What makes student loans different to ‘normal’ debt? ✨
Student loans work very differently to consumer debt such as credit cards or personal loans.
If you (somehow!) took out a £50k personal loan, you would pay it back by making monthly payments to the bank for the time period you signed up for. The size of those payments would depend on on how many years you wanted to spend paying it back, and what interest rate you could get. You would owe this money each month regardless of your personal circumstances, until it was fully paid off. In this situation, the faster you pay it off, the cheaper the loan will be.
Student ‘loans’ work differently, as monthly repayment amounts are not based on your loan balance and interest rate, but based on your income. You only make repayments on a proportion of your income above the ‘repayment threshold‘ (currently £2,274 per month for Plan 2 loans). If you earn below the threshold for your loan you make no payments at all.
This means that future repayments will never become unaffordable, no matter your circumstances. If your income drops, your payments drop, or stop entirely. This is why student loan payments are commonly described as more like a ‘graduate tax’ than a loan.
Additionally, after a certain period of time (exactly when depends on your loan type), any balance still remaining is forgiven. Your balance could be lower or higher than you started out with – either way it gets written off, rather than following you into old age.
These two key features mean paying off your student loan is never an emergency. It may not even be beneficial at all.
Why could paying your loan early cost you money instead of saving it?
The special rules around UK student loans mean that overpaying doesn’t necessarily save you money.
For example, if your income stays below or around the repayment threshold, you will make no or very small payments towards your loan. At the end of its term the loan will be forgiven, and it won’t make any difference whether you started out with a £10k loan or £50k, what the interest rate was, or what the balance ended up at. Pouring extra money into the loan will be of no benefit – it will literally just be money wasted.
Even with more income, if your balance is high you may find that you’re not on track to pay it off with your expected level of income. The best way to check is to use a calculator.
Calculate: Will you see any benefit from overpaying your student loan? 🧮
There are a few calculators out there which demonstrate what will happen if you make only the standard payments. Note they all use different assumptions about future interest rates and income, so you may wish to try more than one:
Note that real life will never look like a spreadsheet showing 30 years of uninterrupted 2% pay rises. You may have a £25k job now but be applying for £40k jobs next year. Conversely, you may end up starting a family and switching to part time work, halving your income.
If you already know about some factors like this, you can include them in your calculations. But even if you don’t yet know how your life will diverge from the spreadsheets, it’s important to remember that it will somehow, and the numbers you see are only a guide.
Some of the calculators allow you to enter in regular or one-off overpayments to see the impact they have. Do they make the loan shorter and cheaper, and if so by how much? This will depend on how far you are into your loan, what your balance is, and how much you can overpay by.
It’s possible you will find that making extra payments is likely to be just throwing them into a black hole, and it’s cheaper to let the loan run its course to the end of its schedule. If so your decision is easy – do not overpay your loans!
If on the other hand you work out that making extra payments will help you pay less overall, then next you have to weigh that against other possible uses for the money.
Prioritise: Do you have more urgent goals (e.g. saving for a deposit)? 🏠
It is important to look at your finances in context. Our famous flowchart is designed to walk you through this, and going through it properly is highly recommended.
In summary though, if you have any expensive consumer debt such as credit cards, you’ll definitely want to work on this before thinking about your student loan.
If you have any short or medium term goals, such as saving up for a deposit on a home, for a break from work to travel, for a wedding, or anything else important to you – please do not delay these life plans in favour of paying down your student loan a bit faster.
It’s also completely understandable if you don’t yet have any specific plans. Do not be fooled into thinking that means paying off your loan is better than having the money sit around ‘doing nothing’ – remember that flexibility is itself a benefit.
If you make a student loan overpayment, you cannot borrow more money back on the same terms. In contrast, money that you keep in a savings account or ISA could be used for any purpose, including student loan payoff in the future.
You should only overpay student loans with excess money that you are certain you won’t need for anything else, not with money you’re not sure about.
Compare: Can you beat the loan interest rate? 📈
If you have established that making overpayments will (almost definitely) save you money, and that you don’t need this money for anything more exciting than financial efficiency, then the last question to consider is whether it better to pay off your student loan or save and invest elsewhere.
This will depend mostly on the interest rate. Different loan types will have different rates, listed here on gov.uk. The higher the interest rate on your loan is, the more likely it is to be worth paying off faster.
As our intro to investing page says, since 1950, investing in equities has produced an annual after-inflation return of 5.2%. This is not a guaranteed or consistent annual return, but rather an average for long term investors.
Plan 1 interest rates are currently at 4.5% and Plan 2 interest rates are currently 6.5%. However they could go up or down each year. At these rates, choosing between overpaying and investing is really a matter of personal preference and individual circumstance.
Don’t stress it – if you’re in this situation, either option is perfectly reasonable. If in doubt, keep your savings accessible and come back to the decision in a year when you might have more information.
Additional Resources 🔗