With the current student loan interest rate at 6.9%, you may be worried about your increasing balance and overall repayments. First of all, it’s important to understand that most people will not be able to clear the debt before it is forgiven after 30 years. According to the Institute For Fiscal Studies, 83% of English students won’t clear their student loans within the 30 years. On the other hand, if you are a higher earner, you’ve probably worked out that you’ll end up repaying much less if your start making voluntary payments as soon as possible. I personally owe over £10,000 and will end up repaying a lot in interest if I don’t aggressively try to pay the debt. However, I’m going to explain to you why paying it back could set you back instead of helping you financially.
What you pay depends on your income
You probably already know that the amount you’re required to pay every month depends on your income. Ultimately if your income were to decrease or if you lost your job, you won’t have to pay a penny. This means that your student debt does not work against you the same way other types of debt do such as car payments or credit card debts which you are required to repay regardless of your situation. This is an important point to remember as when the debt is cleared, you cannot get that money back. Alternatively, you ought to think about what you could do with the money instead of using it towards your student debt.
Save for a house deposit
According to the Office of national statistics, over the 5 years leading to June 2022, house prices increased on average by 7.8% in the UK. Not only has it become extremely difficult for the average worker to afford a home in the UK but the rate at which house prices increase outperforms the current 6.9%. Remember that in most cases you should put your money where the highest interest rate is, thus, if one of your long-term goals is to be a homeowner, you should prioritise this instead of your student loan. Additionally, due to the housing shortage getting worse, house prices are set to increase at a steeper rate in the future, so by the time you finish repaying your debt, it’ll be even more difficult to get on the housing ladder! Would you rather be debt free and still renting or become a homeowner sooner with a student debt that you’re not required to repay in full?
The S&P 500 vs your loan’s interest rate
Here the idea is to simply invest some of your disposable income in funds that will outperform the interest rate of your student loan. If you don’t know much about investing, as a higher earner you should thoroughly study it and start investing your money since it’s constantly losing its value due to inflation. To put it simply, index funds are investment funds that follow a benchmark index, they essentially track the components of a financial market index. The S&P 500 index funds track the 500 leading publicly traded companies in the United States. According to Investopedia, the average annualised return of the S&P 500 since 2007 is 10.49%. The key point to remember is that investing in the S&P500 is a long-term game, the sooner your start, the better. You may want to try to clear the debt first and start investing right after, this may sound like a good strategy since once the debt is cleared you’ll be able to invest more of your money. Let’s see why this is actually a losing strategy.
First case scenario
You make £50,000 and pay £145 per month towards a postgraduate loan. If you owe £11,201 at 6.9%, it will take you 12 years to clear the debt without making voluntary payments, so you decide to throw an extra £500 each month to clear it in just 2 years! You then invest £645 each month in the S&P 500 for 10 years with an estimated annualised return of 10.49%. In this scenario you’ve paid an extra £1,065 towards your debt in interest and earned £58,497.21 from your investment, your net interest earned is then £57,432.21.
Second case scenario
You still make £50,000 and owe £11,201 at 6.9 with the same minimum payments of £145 each month. You decide to ignore your debt and instead invest the extra £500 every month towards the S&P 500. This is where the power of compounding can be counterintuitive! At the end of the 12 years, you’ll pay an extra £4,671 in interest towards your student debt, but you’ll have accumulated a total of £71,106.84 in interest by investing in the S&P 500 index. Your net interest earned will be £66,435.84 over the twelve years which is almost £8000 more than the first example.
Remember to use a stocks and shares ISA for your investments to avoid paying taxes on capital gains.
Conclusion
Ultimately, the key point to remember is that unlike “bad debt” such as credit card or payday loan debts, your student loan is not there to put you in a difficult situation, so it’s in your interest to leave it and work towards other goals. You’ll be better off investing your money towards a higher interest rate or saving up for a house deposit. For example, you could open a LISA and an easy-access savings account if you’re planning to buy a property in the near future. Keep in mind that in that case investing in stocks and shares is not necessarily a good idea since investing is a long-term strategy!
