Why is it not logical to pay off just the interest on your student loan?

silvercar

https://forums.moneysavingexpert.com/discussion/comment/81898342#Comment_81898342

Some problems I can see with your model and potential solutions.

You have made a big and generally erroneous assumption that the graduate’s salary remains flat over 30 years. Graduates start on lower salaries and then their income increases. This has a big effect on loans as interest is added in early years without any repayment of debt and generally not even covering the interest.

You cannot consider plan 2 and plan 5 loans identically. Plan 2 loans have a high interest rate, so the decision is more crucial for higher earning graduates who could clear their loans and pay a lot of interest. With lower interest on Plan 5, the urgency is lower.

ISA as an investment strategy; you can only invest £20k a year.

I struggle with the idea of a graduate investing 5% per year. With high rents/ large mortgages combined with low initial salaries I suspect a lot of graduates don’t have 5% of their income (on top of student loan repayments) spare to invest in the early years.

Although I’m making these points, I agree with your conclusion that it is difficult to jump to the assumption that paying off a student loan is automatically a good idea.

(Parent of graduates, one with a plan 1 loan and one with a plan 2).

2hc9kmju

https://forums.moneysavingexpert.com/discussion/comment/81898547#Comment_81898547

Hi silvercar,

Thanks for the feedback.

I agree that there are many issues with my comments in terms of determining a definitive plan - that wasn't their point.

They are simply indications of inflexion points in the decision-making process. If you aren't yet earning £50k, then you aren't yet paying off enough to repay the debt in full. But this needs review (I suggest annually) to see how your circumstances develop.

As for investing 5%, if you can overpay (the premise of the OP's question), then overpaying into an investment vehicle like a Stocks and Shares ISA (which can, but isn't guaranteed to return more than invested) or even a cash ISA instead of over-paying is an option to consider, as that means you retain control of the cash and in the future if your circumastances mean that over-paying is financially beneficial, you have a pot of money to do so.

Why an ISA - simply because of the tax-free status, which would normally give higher yields than a non-tax-free option, especially if the interest exceeds your tax threshold for interest. Also, if you are self-employed in business, rather than salaried and thus may be completing a self-assessment return, ISA interest or gains aren't added to the income used to calculate your debt repayment…

So ultimately, the Graduate needs to conduct a periodic review of their financial circumstances and assess whether paying off a lump sum or all of the loan is financially beneficial.

I was shocked to read a headline the other day about a student who took out a bank loan to pay off their student debt "because it was cheaper". If you need to borrow money to pay it off, then you probably shouldn't (borrow or pay it off).

Nice that we agree on the overall position, which is that paying off student debt isn't an obvious call for most students, mainly because too many things can change.