Martin Lewis: check the maths before paying tuition fees upfront
The popular money-saving expert kicks off his new monthly column with a look at tuition fees
The popular money-saving expert kicks off his new monthly column with a look at tuition fees
7:14AM GMT 20 Dec 2011
Don't pay your children's tuition fees for them. This isn't a ''let the little blighters pay their own way'' rant, it's a warning to check the maths first. Detaching the noose of student debt may feel laudable, but could leave some throwing away tens of thousands of pounds.
It's now less than a month until UCAS applications for 2012 students close. Yet across the country there are myths and misunderstandings about the new £9,000 annual tuition fees in England. Many parents are scrimping, saving or even borrowing so that their offspring needn't be burdened with them.
Yet while we call it a student loan, it isn't a loan in the traditional sense. It's a hybrid form of finance, nestling half way between traditional borrowing and taxation.
While many parents' understandable reaction is to throw the kitchen sink at rescuing their children from this perceived debt, shelling out may not be the best course of action.
Put simply, many students won't repay even close to what they've borrowed before the debt is wiped clean after 30 years; and if that's the case, paying upfront is a waste. Yet that message isn't getting out there.
A costly role model
Some weeks ago a newspaper called me for a comment: "We've a great story. A girl has saved up nearly £30,000, so her parents won't have to borrow to pay her £9,000 tuition fees – she's a role model." They thought I'd whoop for joy at her savvyness, but while it's a "bravo" for the savings habit, the statement is wrong in so many ways and risked doing damage to her parents' finances.
First, everyone must understand that neither parents nor students pay tuition fees: graduates repay them, but only if they earn enough after they leave. The potential nightmare stems from the implication that this girl's parents had planned to take on commercial borrowing so that she could avoid a student loan. In most circumstances, financially, this would be an aberrant decision.
Unlike normal debts, student loans do not go on credit files, repayments are proportionate to income, which stop if you lose your job, and there are no debt collectors. And while 2012 starters' interest rates are sadly increasing – they're currently at RPI (Retail Prices Index) plus 3 per cent – in the long run they're still far cheaper than credit card and loan deals.
Pay upfront and you could lose £10,000s
Assume the simple scenario of students paying the £9,000 fees each year upfront. Then after they graduate they become low-paid artists, full-time parents ... any scenario where they never earn over the £21,000 salary threshold for paying back the funding. In these scenarios, the £27,000 would have been paid unnecessarily.
While those are extreme cases, the inspiration for this advice came when I first plugged a nerdy calculation into my studentfinancecalc.com tool. I couldn't quite believe what I saw.
Repaying a student loan is not like repaying a loan from the bank. It is linked to how much you earn, rather than how much you borrow.
Graduates only repay 9 per cent of any earnings above the threshold limit of £21,000. So if you earn £22,000 in your first year you repay just £90 of the amount you borrowed to pay for your fees.
If at the end of 30 years the total amount you have repaid fails to cover the total amount you borrowed plus interest accrued, it won't matter as the outstanding amount will be written off.
It is also worth noting that the payment threshold will rise each year, in line with earnings (we don't know how as yet), so if your pay rises do not keep up, your repayments could fall.
Using my online calculator, a new graduate earning £25,000 who took out a student loan for both the tuition fees and the maintenance fees amounting to £46,400 in total, would pay back just £3,400 more over 30 years than if he or she had borrowed only the maintenance fees of £21,500 and paid the £27,000 tuition fees upfront.
However, if a student earned £35,000 in their first year, which then rose at 5 per cent above inflation, paying the tuition fees upfront and using a student loan to pay for the maintenance fees would work out cheaper.
I have calculated that you would repay £49,700 less over the 30 years if you borrowed just the maintenance fees, than you would if you'd used a loan to pay for both tuition and maintenance fees (though you'll have paid £27,000 in tuition fees upfront).
Yet short of employing a crystal ball, how do you know whether an 18-year-old student will be a future high earner? Even those starting higher education destined for medicine, the Bar or the City might change their minds, not get the grades, go into local politics or become full-time parents.
Stash the cash until you know more
The simple strategy is to put spare cash into a top cash Isa or savings account until graduation, when a student will have a better idea of earnings potential.
However, be aware that while studying, the loan interest will be RPI plus 3 per cent, which will not be fully offset by savings interest. So weigh that up against the risk of paying upfront unnecessarily.
A bigger spanner in the works is the Government's ongoing consultation on whether it should introduce early redemption penalties. In my view that would be a perverse decision, as we've been banning it in the private sector for an age. If it did happen, it would shift the risk balance.
Use the money to prevent 'worse' debt
After studying, many go on to buy a house or get a car loan. While personal loans are at far higher rates than 2012 student loans, in the long run mortgages are likely to be roughly on a par. Yet a cash lump sum used as a substantial deposit could enable much cheaper borrowing and decrease the risk of arrears if you had a work break or income fall.
It isn't a sensible strategy to use the cash to avoid a student loan if you'll effectively need to borrow it back from a commercial lender later.
So that's the maths, but of course that isn't the be-all-and-end-all: the moral decision is yours. Many want to discourage debt-averse behaviour. And bear in mind that if you have the cash, but deliberately don't use it as your child will not need to repay the funds in full, it's the Treasury and taxpayer who foots the bill.
Martin Lewis is the creator of www.moneysavingexpert.com and head of the Independent Taskforce on Student Finance Information.
