Student finance: seven things you need to know about your loan

From interest paid to when your debt will be wiped off: we answer the burning questions about student loans

A graduate surrounded by coins
Students now typically graduate with £50,000 in debt

Around 400,000 students are preparing to start university this September. The vast majority will be taking out a student loan, whether it be to cover their tuition, living costs or both.

Tuition fees are now as high as £9,250 a year, with most institutions charging the maximum. Students starting this year can borrow up to £12,010 a year for living costs, depending on where they study and their parents' income.

A typical graduate will leave university with around £50,000 in debt according to the Institute for Fiscal Studies, a think tank.

In theory the loan system is simple. Graduates pay back what they owe, plus interest, out of the income they earn above a certain threshold. What isn’t repaid within 30 years is written off.

In practice, however, the loans are very complex. Telegraph Money has rounded up all you need to know.

1. How you will repay the loan

Starting from the April after your graduation, you will pay back 9pc of the amount you earn over a threshold set by the Government, which is taken directly from your wages, unless you are self-employed.

For current graduates this level is £26,575 before tax in England and Wales and £19,390 in Scotland and Northern Ireland. These will change to £27,295 and £19,895 from 6 April 2021. 

The thresholds change most years. If they go up, you will end up paying back less per month. If you don’t earn more than the threshold, you will pay nothing.

Only tuition fee loans and maintenance loans need to be repaid. Grants, bursaries and scholarships do not. 

2. The 30-year cut off

Student debt isn't like other debt, as anything remaining after 30 years (or 25 in Northern Ireland) is, under the current system, wiped. However, the repayment rate and threshold will dictate how much you pay over those 30 years.

The interest charged on the loan could make the difference between paying it all off before 30 years, and having a debt balance left at the end. 

3. How the interest rate works

Interest starts accumulating when you first take out the loan, so your debt builds up through university.

The interest rate works on a sliding scale. For Plan 2 it ranges from the RPI (retail price index), a measure of by how much prices rise and fall, to RPI plus 3 percentage points. RPI is currently 2.6pc, so the maximum interest you would be charged is 5.6pc. 

The scale is dictated by earnings. Those earning under the relevant repayment earnings threshold, so £26,575 for current graduates, will be charged RPI only. It stops increasing when you start earning more than £47,835, at which point it's capped at RPI plus 3 percentage points.

The rate each year is based on the level of RPI in March. This year's interest rate for student loans, which is between 2.6pc to 5.6pc, is significantly higher than mortgage or savings rates. 

On Plan 1 student loans, which students in Scotland and Northern Ireland have, you also pay 9pc on whatever you earn over the threshold. This is currently £19,390 a year before tax. 

The interest rate is usually set by whichever of the following is lowest: the RPI rate from March of the same year or the Bank of England base rate plus one percentage point. RPI is currently 2.6pc and the Bank of England base rate is 0.1pc so the current interest rate on Plan 1 student loans is 1.1pc. 

One quirk to be aware of is that you will be charged the maximum interest rate while you are still studying.

4. The interest rate can matter

Someone with £60,000 of debt and a low wage is unlikely to pay back their loan within 30 years, regardless of the interest rate. For those people, the repayment rate and threshold are the main points of concern.

However, that doesn’t apply to everyone. If you are likely to pay back your loan within 30 years, the variable interest rate could significantly increase the length of time it takes to pay it off, increasing the total cost of the debt.

5. Student debt can impact getting a mortgage

Your student debt won’t affect your credit score, but mortgage lenders have to take your student loan payments into account in their affordability testing.

That means a student debt could negatively affect your ability to buy a house.

6. You will notice the payments

Student loan payments are taken from your pay before you receive it, just like income tax and National Insurance are.

Many believe that this means they won’t notice the cash going out. However, it will become very clear any time you receive a pay rise.

Say you earn £25,725, and get a pay rise to £30,725. Based on the current repayment rate, 9pc of that £5,000 would go on your student loan, plus 20pc on income tax and 12pc on National Insurance.

Without your student loan payment, you’d be left with £3,400 of your raise after tax. With the payment, you would be left with £2,950.

In the higher-rate tax band, the combination of 40pc income tax, 2pc National Insurance and 9pc student loan payment pushes the effective rate of taxation to 51pc on every pound earned over the £50,000 higher-rate threshold.

7. Early payments could save thousands, or cost thousands

If you are set to pay back your loan, and you make early payments, it could save you thousands due to reducing the amount of interest incurred.

However, if you are unlikely to pay it back, and you make extra payments, you will be throwing money down the drain.

The difficulty lies in the fact that nobody knows how much they will earn over their careers, or what future changes to the loan system may be.

Graduates in lower-earning careers are unlikely to repay the whole amount before it is written off after 30 years, so they or their families would lose out by paying up front.

For higher-earners, however, the savings from upfront payment of tuition fees could be substantial. 

Take a graduate who gains employment at a starting salary of £35,000, increasing each year at 4pc above inflation. 

Annual tuition fees, plus maintenance loans of £8,340 a year, would cost £53,000 paid on graduation, versus paying back £96,000 gradually over 30 years, a saving of £32,500.