Undergraduates may borrow tens of thousands of pounds to fund their education but when it comes to paying back student loans, the rules can be confusing.
What will you borrow?
“Student loans are a complex topic, and there are many myths out there, so it’s important students understand the repayments, their obligations and the implications for future borrowing,” Paula Roche, the managing director of consumer solutions at Equifax UK, says.
That will depend on the timing of your degree, as well as where you are from, and where you choose to study.
English universities can charge home students up to £9,250 a year. Undergraduates in England can also take out a maintenance loan of up to £12,667 to cover their living costs. Maintenance grants were discontinued in 2016.
Loans do not have to be repaid until after you graduate but attract interest while you are still studying.
What is the interest rate?
Student loans accrue interest from the day the first payment goes into your bank account, or to your university, until it has been repaid in full, or cancelled. Interest is calculated daily and applied to the balance each month, what is known as compound interest.
The rules depend on the repayment plan you are on: there are four different ones but if you are an English or Welsh student, who started an undergraduate course anywhere in the UK in the last decade, you are on plan 2, so we have looked at this option.
While studying, the interest rate charged is usually based on the retail prices index (RPI), which is a measure of inflation that includes housing costs plus 3%, but after graduation the rate is pegged to your earnings. The rate is usually set on 1 September each year, based on the RPI of the previous March.
If you earn £27,295 or less the interest rate charged is the inflation figure but if you are making more than this, you pay a higher rate linked to your salary. It is a sliding scale, and borrowers reach the maximum rate of RPI plus 3% once they are earning about £50,000.
How much to repay
Full-time students start repaying their loan through the tax system from the April after graduation but these automatic repayments only start once your income is over the threshold amount for your repayment plan, which, in this case, is £27,295 a year.
This works out as a monthly salary of £2,274, or £524 a week, in the UK. If your income falls below this, the repayments will stop until your earnings recover.
In plan 2, students pay 9% of what they earn over £27,295, irrespective of the size of their debt.
It is possible to make extra repayments but this is not recommended by financial experts. The government advice is to “think about your personal and financial circumstances and how these might change in the future” before doing so.
Borrowers should only make extra payments if they expect to fully repay the outstanding balance by the end of the 30 years.
At present, only about a quarter of students do this, although this figure is expected to increase as, from next September, students in England will have to pay back university loans over 40 years.
Who doesn’t have to repay?
Graduates do not have to make loan repayments if they earn less than £27,295, and the balance will be written off after 30 years. That means someone who never earns more than this would never pay any of their loan back.
A student loan may be cancelled for people who can no longer work because of illness or disability and claim certain benefits, including personal independence payments, disability living allowance, industrial injuries disablement benefit and severe disablement allowance.
It is also written off if a student dies. Family members need to inform the Student Loans Company (SLC) and provide evidence, such as an original death certificate and the individual’s customer reference number.
What about tax?
Repayments are based on pre-tax income but the money is taken after tax has been paid. Someone with an annual salary below the repayment threshold of £27,295 should not make any student loan contributions.
However, a repayment may be deducted if income goes above the weekly or monthly limit of £524 and £2,274 respectively, for example, through working extra hours or receiving a bonus.
Overpayments can be reclaimed at the end of the tax year by contacting the SLC.
What if you move abroad?
It is a myth that student loan repayments can be avoided by moving abroad. Those planning to move abroad for three months or longer should contact the SLC, which will work out what repayments need to be made and, if so, how much.
This only applies to people working abroad, not for studying, volunteering or travelling.
Graduates living abroad need to pay the SLC directly rather than money automatically deducted from their salary, either through their online account or by international bank transfer.
The rules for repayment are the same as in the UK, but there are different earnings thresholds for each country to reflect the variation in living costs. For example, in the US the threshold is the equivalent of £32,755 and in Singapore £16,380.
Anyone who fails to give the SLC their income information will have to pay a fixed monthly repayment rather than one based on earnings, which could end up costing more a month.
Britons who do not make student loan repayments while they are abroad will build up arrears.
According to the latest government statistics, 54,700 graduates were living abroad and paying back their loan – up by 8,700 people – but the number of borrowers who defaulted in arrears jumped 1,500 to 49,500 in April.
Does it affect mortgages?
Student loans do not appear on credit file or affect credit ratings. However, it could still affect how much a bank is willing to lend those applying for a mortgage as take-home pay is considered.
“The first thing to know is that student loan repayments do not directly affect your credit score,” Equifax UK’s Roche says. “They won’t show up in your credit report, and won’t directly impact your ability to take out a loan in future.
“This is because they are deducted from graduate income automatically, before the money hits your bank account, and this will only happen when you earn more than the threshold amount.
“However, student debt accrued in other ways will show up on your credit report, for example, credit card spending, overdraft use and other personal loans such as for a mobile phone.”