Paying for student loans

Question

I am looking for some advice in paying off student loans for me and my girlfriend. As a disclaimer, I am unfortunately quite financially illiterate, but looking to improve.

We are both living in the EU, with identical loans from student finance UK, amounting to about 20K with interest of about 6%. As per the contract, the interest is variable.

The default repayment scheme is 9% over some common sense threshold of the income. If no income, there is no repayment.

We were thinking about paying off the loans faster to avoid paying too much interest. The problem is that we don't earn too much as of now, being at the beginning of our careers. Therefore, what would be the best approach?

• Work on paying one loan, and then the other
• Pay the same towards both of them
• Do not make paying off the loans a priority just yet and pay the minimum until we are in a better financial position (here i'm basically asking how much importance/urgency should we have for this matter)

Answer 1

Short answer: Do not pay any more to these loans than you have to; they are not normal loans.

From the details you have provided it sounds like you are both on Plan 2 student loans.

Remember that UK student loans are not like other loans (they are far more like a tax than a loan). As you said in your question, the minimum payments are directly tied to your income (i.e. no income means no payments are necessary). The detail that is missing, though, is that any remaining balance on Plan 2 loans will be written off 30 years after you graduate (see Student Finance's T&C handbook).

Unless you expect your income over then next 30 years to be so much that you will pay off the whole loan (which is not the case for the majority of students), then my advice to you would be to allow your repayments to be repaid through HMRC, but not pay any extra.

Answer 2

As a slightly different perspective, the Dave Ramsey philosophy is to focus on a cash reserve first, then attack debt aggressively. The basic idea is so many people get into debt because they don't have a cash reserve for emergencies. So while you do lose something like 4% nominal as Lawrence mentioned, you may well avoid larger fees and expenses in the end by having a cash reserve. The other side of his philosophy is the beans and rice budget where you eat and live very cheaply while building cash reserve and paying down debt.

On the other hand, you can only decrease your expenses by so much, but there are more options for making more income. No matter what, the way to get ahead is to spend less than you make.

You may be financially illiterate now, but you won't be for long if you keep asking, reading, and learning.

Answer 3

Even though you may not be making much money, because of your loans, you have found Personal Finance! So, that's a positive. Here is what I would recommend.

Short answer: Do make paying off the loans a priority.

Whether you pay the same towards both, focus on your loan and let her focus on her loan, or pay one off first while you make minimum payments on the other, you and your significant other have to determine that. Below are some questions which may help.

1. Do you intend to stay with this person for the long run?
2. Do you have the same financial goals?
3. What would happen if you were to split up? Would you two be mature enough to untangle your mixed finances without causing greater financial harm later on.

Only you two can answer those questions and decide what is best. No matter which route you take, however, both of you have to get educated on personal finance. I'm sure there are many questions/answers on this and other sites about getting started but below are my 2 cents.

1. Read Rich Dad, Poor Dad by Robert Kiyosaki - there is something about this book which makes sense to a lot of people, including myself--once without a single kernel of knowledge of personal finance--that just clicks.

2. Listen to Podcasts while you cook, drive, commute to work or have some spare time. Personal Finance isn't that difficult of a subject. Exposure to these concepts will help you build your own personal finance playbook. Mad Fientist has a great money podcast and so does Bigger Pockets. Probably one of the more famous people, Dave Ramsey. One small, but important note, DON'T buy expensive courses or programs that promise to help you become better at personal finance. Anyone who is heavily invested in personal finance will tell you that you don't need to pay for this knowledge. There is no secret to any of this.

3. Budget! Perhaps, the most important concept of personal finance. PF is like football, you have to defend and attack. Budgeting is how you align your players. Without a budget, you won't forget to pay your bills but you also won't forget what your working towards. I've budgeted money in so many different ways depending on what my financial situation was at the time over the years. There is no right or wrong way, but you have to do it.

4. Be consistent in your approach. Try to cook meals at home. Check your spending to see where you can reduce costs. Consistently work towards paying your loan off. Continue to budget. Continue to save a bit of money. With personal finance, it's not about just learning what to do, but how you will implement it for the rest of your life. Believe me, life is better with a bit of personal finance knowledge.

5. I like to write about personal finance. Here is my first blog post on checking accounts: Checking your checking.

Below are some additional thoughts I would have if pondering on which decision is best.

If I work on paying one loan off first, I would want to pay the smaller loan first. This will provide an incentive of progress. Many people want to start with the larger loans but sometimes fail because they see no end.

If you pay the same towards both, maximize what you want put towards both. I would probably keep the loans separate, meaning, what you pay towards your loan is coming from your money and what she pays towards hers, comes from her money. Many relationship problems arise because of money, so hopefully keeping the loans separate will aid in any tension money creates later on. But this is solely my opinion. My wife and I keep all of our finances together. She has always been there when I've had financial woes and I do the same for her. It just works for us.

If you do not place much importance to the loans, then what else are you going to do with your money? If you are going to be irresponsible with it, then best pay off your loan first. If you are going to be purchasing a home together, then maybe making minimum payments is best. There is risk and reward for any route you take. It's important, however, that you both are in accordance in your plans.

I hate to give you an open-ended "answer" to your question. But personal finance requires careful thought about your life and general knowledge of yourself. Will you be able to sleep well knowing you have debt? If not, then pay off your loan first. My health is always important to me else I can't work.

And congrats again on finding this road. Hope this was helpful.

Answer 4

You are seeking advice on:

1. Whether to focus on paying off one loan first or split the repayments between both loans.

2. What priority to assign to repaying the loan.

On #1, it’s literally 6% of one and half a dozen percent of the other, so it makes no difference financially. It makes sense for each to pay off their own loan from their own income, but the decision point is common-sense or social or relational etc, not numeric.

On #2, I’d expect that the reason there’s a minimum threshold on the salary before repayments start, and then only a small percentage taken for repayments, is to cater for living expenses and to start building a buffer for a rainy day.

Financially, if you are paying 6% interest on the loan and earning, say, 2% interest on deposits at the bank, you are effectively accruing 4% interest so that you have 100% liquidity. Let’s illustrate this with some numbers:

Consider a $100 portion of your loan. If you have $100 spare cash (after accounting for rent, food, minimum loan repayments, etc), you could pay off that $100 portion of the loan in full, leaving nothing for yourselves. Or you could keep your $100 spare cash in the bank, earning $2 deposit interest after one year, but accruing $6 loan interest. In this scenario, you are effectively paying $4 per year for the privilege of retaining access to your $100 spare cash for the duration. After 5 years, for example, you’d be effectively paying $20 in total to hang on to the $100 principal.

This answer isn’t financial advice tailored to your specific financial situation. It just gives you a bit of context about the trade-offs with making or not making extra repayments.