Student loans are a tough financial lesson to learn.
Millions of new and existing graduates fear the Budget could confirm changes to the student loans system that have been dubbed a tax raid on Generation Rent.
This week, the Financial Times reported that the government is considering lowering the salary threshold at which graduates start to repay their loans from £27,295 to about £23,000, meaning lower earners would pay back many thousands of pounds more than they do under the current system.
Money Saving Expert Martin Lewis has vowed to take on the government if any changes apply to existing graduates, stating this would be “an absolute breach of natural justice”.
Once a contract is signed, no commercial loan provider can retrospectively change the terms and conditions without agreement — but the government can if it so wishes.
They might be called loans, but student finance is more akin to a graduate tax. Nine per cent of earnings above the repayment threshold are automatically deducted from your payslip until you have repaid all of the debt and interest, or 30 years has passed.
Today, a graduate earning £27,295 would have nothing to pay. If these changes happen, their annual take home pay would be cut by more than £800. If you’ve already started repaying your loan, you could expect annual payments to increase by around £400.
This would really hammer the finances of lower-earning early-career graduates, who already stand to be hit by higher national insurance payments next year. However, starting earlier could reduce the total amount that higher earning graduates repay over their lifetimes as they’re more likely to clear their loans within 30 years, so stand to save thousands of pounds in interest.
The interest rate on student loans is linked to inflation (RPI), which presents a further problem. I’ve been contacted this week by parents who wondering whether they should help repay student loans early, or forward-fund university costs from their own savings.
Much depends on a student’s future earnings power, which is a hard thing to predict, says Ben Waltmann, senior research economist at the Institute for Fiscal Studies.
He’s come up with some estimates based on graduate earnings at the age of 30 (by this time, people tend to be more established in their careers and their lifetime earnings are slightly easier to model). He’s also assumed average graduate debts of £53,000 for students in England who start courses in 2021.
Under the current system, the IFS estimates that about one-third of graduates who earn a salary of £40,000 by the age of 30 will end up paying back more than they borrowed in real terms given the interest accrued. If they earn £45,000, the proportion rises to around half; by £50,000 it will be around two-thirds.
“As a rule of thumb, if they’re expected to be earning above £50,000 by age 30 and are looking to stay in their career, chances are they will pay back more than they borrowed if they repay on schedule,” Waltmann says.
For these grads, it could make sense to pay off loans off early, but how would these assumptions change if the repayment threshold falls to £23,000?
According to the IFS, about one-third of graduates earning around £35,000 at age 30 would then pay back more than they borrowed; rising to half at around £40,000; and two-thirds at £45,000. So if the cut goes ahead, it could make financial sense for parents of children with somewhat lower early-career earnings to consider this strategy.
Of course, making a £53,000 upfront investment is something that only the most affluent parents will be able to afford. It’s also a massive gamble on your child’s future earnings potential. Your child may never have to pay back that much if they settle for a lower-paying job, take an extended career break to raise a family or cannot work due to ill health.
Waltmann also urges families to consider the opportunity costs of tying up this cash. “Much depends on what else parents or grandparents are going to do with the money,” he says.
The obvious alternative is gifting a cash lump sum to use as a property deposit. In terms of monthly outlay, repaying a mortgage could well be cheaper for your child than renting a similar property. As student loan repayments will crimp what they can borrow from mortgage lenders, a bigger deposit could also help them secure a more favourable interest rate.
Wealthier families may be able to afford to do both — in fact, this could be a good tax-planning strategy for older relatives who want to start the clock on the “seven-year rule” that allows gifts to be made free of inheritance tax.
A further fact to consider is what level of interest your child pays on their student loan. While they are studying, this rolls up at RPI plus 3 per cent (currently 4.2 per cent). When they graduate, the interest rate depends on how much they earn.
Currently, those earning below the repayment threshold are only charged RPI. However, this steadily increases, with those earning over £49,130 charged RPI plus 3 per cent.
“If they’re earning above the upper interest rate threshold early in their careers then they’re pretty likely to pay it all off,” adds Waltmann.
Will younger workers be tempted to claw back a few precious pounds by opting out of their workplace pension scheme? I certainly hope not
In the US, families traditionally start saving into a child’s college fund as soon as they are born. If families on this side of the pond get into the same savings habit, they could harness the tax-saving advantages of Junior Isas. These allow you to subscribe up to £9,000 per year until your child turns 18.
I fully appreciate that reading about the tax advantages available to the wealthiest will be of no comfort whatsoever for graduates like me who come from more ordinary backgrounds.
I was proud to see my three stepchildren graduate from university, but all of them “boomeranged” home afterwards for a spell, and one lived at home while studying to minimise his debts. This won’t be an option for every family, but I predict we’ll see a rise in both trends. However, my biggest fear is that bright children from less wealthy backgrounds will be deterred from going to university full stop.
Finally, consider the dire consequences on young people’s budgets. In future, if a graduate earning over £23,000 gets a pay rise, more than 42 per cent of this could be swallowed up by income tax, national insurance, student loan repayments and the new social care levy.
Will younger workers be tempted to claw back a few precious pounds by opting out of their workplace pension scheme? I certainly hope not, as this could undo the good work of auto-enrolment at a stroke. If Generation Rent grows up to become Generation No Pension, this will be a terrible lesson for us all.