Should the Bank of Mum and Dad Pay Student Tuition Fees?

August 2017
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Many parents, who themselves had a free higher education, are loathe to see their children accruing debt before they have earned anything and if they can afford to do so want to help out. Whether this is a sound financial move depends upon the potential career earnings of the graduate and whether they plan to take long career breaks within 30 years of graduating. In some situations, parental help would be better spent on helping fund a deposit on a property or paying for other capital items which could cost more to fund as an unsecured loan, such as buying a car.

Student debt, charged at 3% plus the increase in retail prices (6.1% in total from September) is expensive, compared to most mortgages and secured loans. Unlike other loans, any outstanding balance is written off after 30 years. Repayments are based, not on what is needed to repay the total over this time, but on the graduate’s earnings in excess of an income threshold, currently £21,000, with 9% of income in excess of this being deducted from pay to repay the loan. In this respect, the higher interest rate may simply mean that more is written off by the taxpayer over the longer term than is paid back by the graduate, unless they become high earners early in their careers and maintain that for most of the 30 years.

Student loan rules since 2012 mean that graduates on the same course can each pay back very different proportions of their loan, depending on their earnings pattern over that 30 year period. The 3 examples below demonstrate how this might work. It is assumed that all 3 graduates borrowed £9,250 x3 for tuition fees and £8,200 x3 maintenance loan a total of £52,350.

By the time they start work this would have grown to £59,908 due to the inflation linked interest plus 3% which is added as soon as the debt is drawn down and so grows throughout the student’s time at university and until the following April. This is when repayments start, once earnings are above £21,000 pa. The RPI linking is adjusted each September, we have assumed RPI 3.1%, the actual rate could be higher or lower. Once earnings reach £41,000 the interest rate jumps to RPI plus 3%. Between £21,000 and £41,000 earnings interest is on a sliding scale of RPI plus between 1% and 3%.

Graduate 1 Works in the voluntary sector. Salary £17,000 p.a. increasing at 2% p.a.

Years to reach threshold Monthly Repayment Debt Outstanding Total Repaid Debt Witten off Repayment as a % of loan
After 11 years £1.03 £85,622 - - -
After 30 years £68.92 £158,669 £7,541 £151,128 4.75%

 

Graduate 1 should not pay off their debt early. Unless they have a significant rise in income they are unlikely to have to pay back more than 14.4% of the original loan, so paying back more than this is money wasted. Parental help would be better directed to other financial support, such as funding a lifetime ISA which will earn a 25% Government bonus.

Graduate 2 Works in professional services company starting salary £40,000 p.a. rising to £67,070 p.a. on qualification then in line with inflation. 

Years to reach threshold Monthly Repayment Debt Outstanding Total Repaid Debt Witten off Repayment as a % of loan
Immediately £142.50 £59,908 - - -
After 5 years £345.52 £72,761 £8,550 - -
After 30 years £640.00 £149,670 £114,841 £34,829  76.72%

 

Graduate 2 should pay back their debt as soon as they can as the interest rate of RPI +3% is an expensive loan and unless their career changes, they are unlikely to see the bulk of their debt written off. Paying only the 9% over threshold income required will mean that despite high repayments, the debt is still growing, leaving this graduate paying back over 219% of the original loan. 

Graduate 3 Starts on £25,000 p.a. salary, increasing to £40,000 p.a. 2 years later, then ceases work after 7 years to start a family. 

Years to reach threshold Monthly Repayment Debt Outstanding Total Repaid Debt Witten off Repayment as a % of loan
Immediately £30.00 £59,908 - - -
After 2 years £142.50 £61,888 £720 - -
After 7 years £142.50 £73,619 £9,270 - -
After 30 years £0.00 £156,141 £9,270 £146,871 5.6%

 

Graduate 3 will start paying back as soon as they start work, if they have a clear intention to take an extended career break, paying back only what is required via payroll deduction is optimal. Paying more than this would be a waste of money. However returning to work within the 30 year time frame from graduation could result in significant costs later, if earnings are in excess of the threshold (£21,000 p.a. currently). This graduate may wish to review their position depending upon long term career and family plans but could only pay back 17.7% of the original loan within the current rules.

As mortgage interest rates are lower than 6.1%, there could be a case for paying off student debt early, as the cost of the student loan is likely to exceed the best current mortgage offers. The fact that student debt is written off after 30 years and repayments are based on earnings, not amount owed, is an incentive for all but the high flyers, to put off repaying more than the minimum until career and life plans are more certain. However maintaining a high level of student debt could adversely affect your credit rating and make other loans harder to obtain.

If you are in a lower paid job or intend to stop work in the future, saving for other purposes first, such as a deposit for a home or long term retirement savings may be more beneficial. This leaves the taxpayer with a large bill and university finance looking vulnerable but from the individual point of view paying back a debt that could be written off in the future is a voluntary tax.

Kay Ingram
Director of Public Policy, LEBC

Please remember, no news or research item is a recommendation or advice to buy. LEBC Group Ltd is not responsible for accuracy and may not share the author’s views. If you are unsure of the suitability of any investment or product for your circumstances please contact an adviser. 

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