Should you pay for children’s university fees outright or should they take the student loan?
Every so often I get questions from my clients about whether or not to fund their children’s university studies. Having looked into this again recently, I though it might be useful to share some thoughts on the topic.
Student loans are structured in two parts, the tuition fee loan, and the maintenance loan. Tuition fees are currently £9,250 per year whilst the maintenance loan varies depending on the household income of the student’s home, where the university they study at is located and whether they live at home or at university when studying. Assuming household income is above £62,286 per year, the student lives away from home and their university is based outside of London, the maximum maintenance loan would be £4,422 per year. Assuming a three-year course, a student could therefore leave university with £42,702 of student loan debt.
A couple of useful points to keep in mind about student loans; they do not have any impact of credit rating and they are written off if not fully paid off after a period of time (30 years after graduating for Plan 2, i.e. post 2012 student loans).
Given the way Plan 2 student loan interest rates and repayments are calculated, I have made a set of assumptions when working out whether it would be a good idea for a child to take on that debt or if it might be better to pay the fees up front. I have assumed 3% per year RPI, 4% per year pay rises and 4% per year increases to the salary threshold which triggers repayments.
Using the above assumptions someone would need to start a job straight out of university on £49,000 per year to pay the loan off by year 30, the year in which it would otherwise be written off. So to pay it off in any kind of reasonable time before it gets written off, the graduate would need to be earning significantly higher than that figure, e.g. a job straight out of university paying £65,000 p.a. in order to pay the loan off in 15 years.
There is a flip side to this though. Graduates don’t start paying back their Plan 2 student loan until they earn over £27,288 p.a. and then it is at 9% of their earnings above that threshold. Keeping in mind that original loan amount which I said could be £42,720, a graduate would need to start a job straight out of university on a salary of £35,296 p.a. to make total repayments over the 30-year period of £42,720. Effectively, that’s the amount they would have to earn, with the 4% pay rises each year to break even on the loan, and that’s just in nominal terms; in real terms, assuming 3% p.a. inflation, they would need to start earning £40,492 to breakeven on the loan at the time it’s written off.
So, what’s my takeaway from this? Well, looking purely at the financial side of this, it is that unless parents (or anyone else considering funding a student’s undergraduate studies) have a high degree of faith that their child is going to leave university and go straight into a career paying upwards of £60,000 per year they should not pay for university. Instead if parents wish to make a significant difference to their child’s finances, they should simply invest that £42,720 and give the proceeds to their child after 30 years (or give it to their child and recommend the child does the same) as, with half-decent investment growth, this would surely be worth more after 30 years than will have been paid in student loan repayments.
There are considerations other than the figures though. There is a risk that over the next 30 years the government could change the rules to say that the loan is no longer written off and instead must be repaid in full; of course the government may not do that, but it is a risk and one that must be weighed up in decision making. There is also the factor of how it feels to be in debt. For some people, regardless of whether or not they have investments with returns that are more than justifying keeping debt, just the thought of being in debt is a stress to them and one that causes some angst. For people like this it might be better to go through working life without the perceived burden of student loan debt.
So, if thinking about paying for university fees for a child, consider the above scenarios, weigh the risks up and most importantly talk with the child about it, explaining the implications and see how they feel.