Is it worth paying off my student loan?
Here are the figures
I always think its better to run though examples instead of trying to explain things blindly so heres some example figures. Student loans are linked to the rate of inflation and for the last 10 years it has averaged around 2.5%. I'm going to give examples from borrowing £4,000 similar to the amount I currently owe. Similarly the average rate of inflation has been 2.6% since 2002
Based on £4,000 each year you will be charged £100 per annum at the average 2.5% interest rate meaning 12 month after borrowing £4,000 you will now owe £4,100.
Similarly if I were to buy something for £4,000 at the start of the year, taking into consideration the inflation rate of 2.6%, the same item 12 month later would cost me £4,104
And finally if my yearly wage was £16,000 one year, 12 month later inline with inflation I would expect to earn £16,416 the following year.
From looking at these figures you can see now that if I don't pay anything off your loan the amount I owe will still stay relatively in-line with current prices. So if I never paid off any of the loan for the next 10 years and providing interest rates stayed the same I would still owe "RELATIVELY" the same amount. So if my loan cost was the same as 5% of your annual wage now, and my yearly income goes up in-line with inflation my loan 10 years from now would still be 5% of my annual wage.
So according to these figures it is probably not a good idea to forget about my loan as I wont want to dish out a large percentage of my annual wage in 20 years time if I decide to emigrate and realize I need to clear my 20 year old student debt!
Staying ahead of inflation
Based on the same figures above if I decide to stay ahead of inflation and pay double what the interest rate will be at the start meaning i pay exactly the same each year this is how the figures add up.
YEAR 1
Yearly wage: £16,000
Loan: £4,000
Annual Interest Charged: £100
Annual Repayment: £200
Amount owed at the end of the year: £3,900 (24.4% of my annual wage)YEAR 2
Yearly wage: £16,416
Loan: £3,900
Annual Interest Charged: £97.5
Annual Repayment: £200
Amount owed at the end of the year: £3,797 (23.1% of my annual wage)YEAR 3
Yearly wage: £16,843
Loan: £3,797.5
Annual Interest Charged: £95.6
Annual Repayment: £200
Amount owed at the end of the year: £3,692 (21.9% of my annual wage)
You can see how earnings go up whilst the amount owed slowly comes down. If I continued this trend and skip ahead 20 years I would still owe £1,534 but my yearly wage in theory would be £26,057 making the loan only a very small 5.9% of my yearly wage. If I didn't do anything else but £200 a year it would take 30 years to pay off my student loan but the amount i would have re-payed in total would have been £6,000 . And to put it into perspective yet again £200 in thirty years time will in theory be worth £100 in todays money.
Paying it all off now!
If I had a spare £4,000 and decided to pay off my student loan now I could, allowing me to save £200 per year, each for the next 30 years in a savings account with an average interest rate of 5%. Saving £200 each year for 30 years, including the interest I would make would net me about £13,000 (roughly equivalent to £6,500 in todays money).
Alternatively if I decided to pay £200 a year off my loan and put my £4,000 into a savings account with a 5% rate of interest, after 30 years this would have netted me £16,000 (roughly equivalent to 8,000 in todays money)
Subsequently by saving I would be earning double the yearly interest what my student loan would be costing me!
Summary
So in my opinion NO, its not worth rushing to pay off that student loan as soon as possible, paying off a few quid each week will cover the interest nicely AND pay off a little of the balance (in-turn bringing down your anual interest charges!)
If you would like to learn more, check out this great resource at Money Saving Expert
Please note, this is only my opinion on my finance, I am not qualified to give out any financial advice, its only my opinion. Interest rates can and will fluctuate so please do your own research or get qualified financial advice before taking any of these ideas on-board!
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This look sound for one debt and on paper but, and you know that a "but" was coming
, you should still pay it faster. Why? Because if you want to get a loan for a house, a car … , this will be part of the overall debt(student loan, credit card limits…) you have.
Maybe it's a country thing but when I asked a for "personal credit margin" a few years back, the person made a credit check. Even when I had paid my credit card on time(100% not the minimum) and seldom was at 10-20% of the maximum, they calculated 100% of each card. They calculate that people "could" max them and could fall behind.
"personal credit margin" : It's French-Canadian translation(marge de credit personel) and did not know the English equivalent but it's like a permanent personal loan that if you don't have money in the bank account, it's taken from that. Once the money(your pay) is deposited into the account, it deduct it there first. You don't have bounce check or ask for a small loan
If I would need a major loan, I would have to lower/removed the margin and it won't be a trouble if it's empty unlike a student loan.
This is something to think about because it would follow you until it's fully paid.
My 2cents
P.S.
Is it a "line of credit"?
Thanks for the comment, I think it may be a county thing as you say. Here in the UK we do have a credit score but that is targeted toward personal (non educational) loans and mortgages etc. The Student loan scheme in the UK is government backed and due to the rules and the minimum payments being so low relative to salary this has virtually no effect on your credit rating. That is unless you do something silly and deffer minimum payments, but overpaying does not benefit your credit score as far as I am aware.
I'm guessing the personal credit margin is the same as "Overdrafts" here in the UK. You can apply for an overdraft where you are allowed to let you balance go negative for a short period and within reason but once you deposit money in it is payed off the overdraft first.
All the best
Andy
I live in the US. My wife just finished optometry school with over $140K in debt. Fortunately our interest rate is locked in at 3.6% and with a good payment history will be at 2.6% after 3 years. It doesn't make sense for us to rapidly pay off the student loan. Financially we'll be further ahead at the end of 30 years, rather than paying off.
I must say that the idea of having a 30 year loan doesn't appeal to me all that much though, but I have to think looooooong term. It's not like prepaying a mortgage, because there's no direct equity or no way to sell it off right away to erase the debt. It's going to be a long road.
See you at my blog in 30 years. haha.
Ouch! $140k yeah it seems weird that it will just be sitting in the background slowly ticking down!
Lookind foreward to the 30 year reunion! lol
I wonder how blogging will have changed in 30 years?!
Andy
Good article! I wrote something about paying off more than your monthly payment on hour home loan, and over the 20 year term of the loan, you end up saving thousands and thousands. It's always good to pay off your loans that have interest. Otherwise you end up making the banks rich……This is of course if you don't have other oppertunities where you could use this extra capital to make more money than what you could have saved.
I came here by accident, but just might stay
I was always told to never rush loan payments to improve credit score, but it does factor into overall debt when you combine student loans with house loans etc.