Yahoo Finance The student loan system: five common myths debunked
Theresa May's proposed overhaul of funding for further education comes as she attacks "punitive" interest rates and other aspects of the current system.
The average debt on graduation is now £50,000, according to think tank the Institute for Fiscal Studies.
In theory the student loan is simple. Graduates pay back their loan, plus interest, out of income once they earn above a certain threshold.
What they do not repay within 30 years is then written off.
In practice, though, the loans are fiendishly complex. The system operates in such a way that few students can have any idea of how much their debt will eventually cost them.
The interest rate varies according both the borrowers' earnings and the prevailing rate of inflation.
The lowest earners, and the very highest, might well end up paying less than those in the middle.
Since parents often play a huge part in financing their children through university they, too, need to understand the loan system.
Here are some of the most common myths and misconceptions.
1. The interest rate doesn't matter
It is true the majority of students are likely to reach the 30-year cut-off point with significant outstanding debt which will then be written off.
As a result many believe the rate of interest is irrelevant. Not quite.
For the post-2012 system, interest on student loans is based on a scale.
Those earning under £21,000 are charged interest at inflation as measured by RPI - currently 3.1pc - while those earning above £41,000 pay RPI plus 3pc, with a sliding scale in between.
Whatever RPI is in March determines the interest rate from September onwards the same year.
RPI in March last year was 3.1pc, which means the current interest scale ranges from 3.1pc to 6.1pc.
Higher interest can add thousands of pounds for those borrowers set to pay off their debt. For others, the interest will prevent them from paying off the loan within the time limit, keeping them making payments for the full 30 years.
2. Interest rates applied to the loan during study are low
Very wrong. One little-known fact about student loans is that interest is applied at the maximum possible rate while you are still at university.
Say a student entered their third year of university with £30,000 in debt accrued up to that point. At the current 6.1pc maximum rate of interest, £1,830 would be added to that balance during the year.
This is particularly damaging for those on longer courses, such as integrated masters degrees.
Only when you start to earn, ironically, does your interest rate drop to a level reflecting your wage, as explained above.
3. I won't notice the payments
One of the times when the student loan repayment amount is most noticeable is if you receive a raise at work.
Say you earn £25,000, and get a pay increase to £27,000.
Out of that £2,000, 20pc will go on income tax, 12pc on National Insurance and 9pc on your student loan.
That leaves £1,180 of your rise.
4. The terms of your loan won't change
You might expect, as with a loan from a bank, that the terms of a student loan are fixed.
But George Osborne proved otherwise in the 2015 Autumn Statement. The £21,000 repayment threshold was supposed to begin increasing with inflation, but he froze it until 2022. As a result, the effect amount graduates were paying back went up.
Last year, Theresa May announced that the threshold would increase to £25,000, reversing Mr Osborne's decision.
Further changes are now being discussed, such as cutting interest rates. This would benefit borrowers, but there is no telling what other alterations will me made in the 30 years of politics to come.
5. I can't do anything about it, so why bother to understand it?
If you are likely to pay back your loan within 30 years, making early payments could save you money due to minimising the time over which you accrue interest.
However, making extra payments when you are unlikely to clear your loan based on the default payments could cost you thousands.
Unfortunately we don't know how much we're going to earn throughout our careers.
But understanding the system puts you in a better position to limit the total interest.
james.connington@telegraph.co.uk
