The big financial question for parents with children heading to uni in September is should I pay my child's university fees upfront or let them take out a student loan?
The thought of their children beginning adulthood with £50,000 of student debt hanging over their heads can be enough for some parents to reach for their cheque book. Surely paying off the initial sum of the university fees upfront is better than your children having to pay thousands of pounds of interest for years to come?
A quick calculation could leave you feeling a little hot under the collar. Student debt may be hanging over your child’s head for decades. Plus, they may accumulate thousands more than the original sum borrowed, in interest.
If you read the small print you will discover that by paying upfront you could be throwing money away. Three-quarters of graduates won’t ever repay the entire amount they owe for the four following reasons:
1. Your child only starts paying off their student loan when they reach the threshold
Until they earn over £25,750 a year, they won’t pay a penny of student loan debt. Unless of course they choose to pay it off early. If they take a career break, go travelling or have time off to look after their children they won’t have to pay off any of their student loan during that time.
2. They only repay 9% of everything earned over the threshold a year
Even when they are earning over £25,750 (£2,144 a month), they will only pay 9% of anything over the threshold. This will be deducted from their income before it reaches their bank account.
Assume that your son or daughter is earning £35,000 a year, or £9,250 above the threshold. The 9% represents £832.50 a year (£69.37 a month).
The amount of accrued debt that your child owes has no bearing on the payment. The only factor is her earnings over the threshold.
3. The student debt is written off after 30 years or when they turn 65 (whichever comes first)
If your child finishes university at 22 the student debt will be wiped off when they are around 52 years old. Unless, of course, you have already paid it off. If they earn on average £38,000 for 30 years, they will repay £45,900.
4. The interest rate is based on inflation (RPI) + 0%-3% and is relatively low compared to other loans
Anyone earning under £25,750 in 2019/20 will pay an interest rate of 2.4% (RPI) and anyone earning over this or still studying will pay an interest rate of up to 5.4% (RPI + 3% on a graduated basis up to £46,305). This rate varies each year depending on inflation, so it could be higher or lower.
It’s not a loan, it’s a Graduate Contribution Tax
Money saving expert Martin Lewis suggests that people should think of student loan repayments more like a ‘graduate contribution tax’. This is because they are based on a percentage of your income over a certain amount, just like tax is.
Due to the majority of graduates never paying off their student loan, the total figure and interest rate is irrelevant. Student debt is unlike normal debt, it doesn’t affect your credit rating. Therefore, it won’t prevent your children from being approved for a loan or mortgage in the future. Student debt is written off when a person is permanently disabled or dies.
When should you pay their university fees upfront?
Hindsight is a wonderful thing. Wouldn’t it be great to know that your child will one day be a successful and wealthy individual and subsequently pay off their entire student loan?
According to statistics, a meagre 17% of graduates are forecast to pay back their loans in full. Even if your child is heading to Oxbridge and predicted to be the next Elon Musk, things can change. They may drop out, become unable to work, change career paths, devote their life to charity or religion, or become a homemaker.
However, if you choose to fund your child’s university education here are a few tips:
- Start investing early to benefit from compound interest.
- Save your money in an ISA or similar investment portfolio.
- Do not take out a personal loan to fund the repayment.
- Seek advice from your financial planner.
What to do with that university savings fund instead?
If you have a lump sum burning a hole in your pocket, in theory you could place it into an investment portfolio or a high-interest ISA. The average return of a medium risk portfolio is likely to be around 7% over the long term (10-30 years). Of course, past performance is no guarantee of future returns and you may not get back what you invested.
This could potentially beat the interest rate of the student loan. You could use this money to help your grown-up child in the future. In 10/15 years’ time, they may want to use the money for a wedding, house deposit, or help fund a young family.
Is your child heading to university? If you would like advice to help you make the best financial decision for you, contact Capital today.
All the data and information in this blog are true when published in June 2019. The blog information is relevant for English students on Plan 2 that began university post 2012. Do seek advice before making any significant financial decisions.