Many people will have come across the headline-grabbing interest rate of 5.6% per annum on some student loans. Many people rightly believe that we should pay off all our debts where possible and should never take out a loan that we know we cannot repay. However, with the average starting salary of graduates stagnant at £30,000 for a fifth consecutive year, and the average debt of recent graduates reaching £40,280 it is no surprise that many recent graduates view their loans more as an ‘education tax’ than a viable repayment vehicle.
It is understandable then those grandparents are keen to help their grandchildren out when it comes to settling this debt.
Student loans, however, are very different from traditional bank loans, and sometimes it can be more beneficial to give your grandchild the money directly to help them with their future.
Plan 1 or 2?
Broadly, if they started their undergraduate course before 1 September 2012, they will probably be on Plan 1. If they started after this date, they are likely to be on Plan 2. If you are reading this article and considering whether to pay off your grandchild’s debt, it is safe to assume their loan will be assessable to Plan 2 but it is always worth double-checking
Student loans are far from straightforward and very few people will ever end up paying the top rate of interest on their loan. Before you settle your grandchild’s debt, there are some key things to bear in mind:
- A student loan does not work like a conventional loan.
- Students start repaying it once they are earning above the threshold – this is £26,568 for this tax year if on Plan 2.
- If they do not manage to clear it during the loan period, the balance is written off – usually 30 years.
This means that extra repayments should perhaps only be made if you think your grandchildren are likely to repay the full balance of the loan before the loan term ends. There is no sense in paying off the full debt now if it is likely to be written off later. As the amount repaid on a student loan is linked to earnings rather than how much is outstanding, you will need to be pragmatic about the likelihood of your grandchild earning enough money to pay off the loan.
Is there a better way?
So, you want to help, but maybe paying off the loan is not the way to go? Are there better uses of these funds?
Perhaps buying a house is a more pressing concern for your grandchild? If they have a Plan 2 student loan, then their loan may have a higher interest rate than a mortgage but the monthly repayments on a mortgage are likely to be far higher than their student loan repayments – and the mortgage certainly will not be written off after 30 years.
If you gifted £50,000 to your grandchild which they invested and achieved modest returns of 3% per annum after fees and inflation, then that investment could be worth £56,275 after five years. This could help with a house deposit. Assuming the same rate of return, it could be worth £117,828 after 30 years, which could help towards their retirement. Please bear in mind that the value of investments fluctuates, and you could end up with less than you originally invested
If you would like some advice on whether or not to help fund your grandchildren’s University education, then please get in touch and one of our expert Wealth Strategists will be pleased to run through the options with you.