Should I Pay off my Student Loan Early?
In many cases paying off debt early in any form is a sound financial strategy as the overall level of interest paid back will mean lower outgoings in the long run making the individual better off. Despite this the student loan is a form of debt with some special features which means that standard advice on debt management may not apply.
Special Features of the Student Loan
Firstly any student loan taken out from the Student Loans Company (SLC) in the UK since 1998 has a number of special conditions which one is unlikely to come across with any other from of debt. One feature of the loan is that unless an individual is self employed or moves overseas repayments only take place through the PAYE tax system. In short repayments take the form of an additional tax, SLC can not make a claim on an individuals assets or make a demand for payment outside of the tax system. In last year deductions only take place after a threshold of £15,000 is reached after which point 9% is deducted on earnings above this figure.
A second feature of the SLC student loan is that the debt expires after 25 years or on death. As such one reason not to pay back a student loan early is that in some cases an individual’s loan may expire before they have paid back the full amount. This may be a consideration were an individual has lower earnings than expected or were a career break or ill health or considered.
The final feature of the SLC student loan to consider is it’s uniquely low cost. For loans taken out after 1998 the rate of interest charged is capped at the lower of either the current rate of inflation or the base rate of interest plus 1%. At present this means that current post 1998 loans are attracting a 0% rate of interest representing by far the cheapest form of debt.
Reasons Not to Pay Back a Student Loan Early
All of the above reasons all given an indication that student loans provided by the SLC have a favourable status amongst credit options however there are several additional reasons not to pay back a student loan early. In paying back any form of debt an individual will benefit from paying off the form of debt which has the highest rate of interest first. Given the special conditions of the student loan this means that in reality it is likely to be the form of debt with the lowest rate of interest. As such if an individual has any other outstanding source of debt it is likely to make financial sense to pay such loans off first.
Assuming that an individual is completely debt free with the exception of the student loan one must then consider the opportunity cost of paying off the debt. In many instances even a poor yield on a low risk investment will yield a better return for the individual than paying off a student loan. For instance at present whilst rates on student loans remain at 0% even leaving the money in a current account yielding 0.5% will still leave the individual better off than if the same money were to be used to repay a student loan.
In summary the student loan represents one of the cheapest sources of finance available with favourable terms and conditions. As such one should consider that much bigger savings may be made by paying off alternative sources of debt first or investing the money at a greater rate of interest than is being charged in the loan.