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Losing Money Every Day

Now that I’m a bona-fide working man, I’ve recently been thinking about whether or not to increase my minimum, compulsory payments to the Students Loan Company (SLC) to pay off my Student Debt. Now this debt is no meagre sum – a fair bit over £10,000 – and at recent projections will take me several decades to pay it off (if I pay the minimum and never receive a pay rise).

Currently it is compulsory to make payments to the SLC to pay off this loan when you earn over £15,000 per year. The payment you must make is 9% of your wage, over the £15,000 threshold. So, if you earn £20,000 annually (pre tax) you must pay 9% of £5,000 a year – £450. For most, this will be paid in monthly instalments throughout the year using the ‘Pay as you Earn’ system (PayE) – you don’t need to do a thing to pay off the minimum.

The SLC student loan does not gather interest though – you may think it does when you look at your annual statement, but what you’re actually seeing is the debt increasing with inflation – calculated using the Retail Price Index.

The SLC loan is guaranteed to only increase at the rate of inflation – for life. This means that the government or the SLC are not making any money from the loan* – it is the cheapest form of debt available. (The UK government has similar WWII debts, and this link explains them and also gives some information on paying off student loans.)

If your bank account gives you interest higher than the rate of inflation, you’ll actively be making money when your funds are in your account doing nothing, so if you were to use this money to pay off an inflation-only loan, you’ll be missing out on the interest your money will earn you whilst it is in your bank account.

Here’s an example:

You owe friend A £5. Friend B owes you £5.
Friend A is not charging you anything while you owe him money but you have 10 days to pay off the debt at a minimum rate of £0.50 a day. You are charging friend B £0.25 a day whilst he is in your debt, regardless of by what amount. You have no money.
Friend A is the SLC loan, friend B is your bank.
Is it better to:
a) Take £5 off friend B on the first day and give it to friend A to be totally debt free?
b) Make friend B pay you £0.50 a day (£0.25 interest and £0.25 of the debt) and pay this directly to friend A daily?
The answer is the second option, as you will pay off friend A’s debt in 10 days (you’re paying the minimum) but over the period of friend B paying back his debt to you (20 days), you will actually end up with an extra £5 in interest.

So, what are we supposed to do? The answer is simple: pay off your student loan at the minimum rate as long as your regular bank account gives you interest at a higher rate than that of inflation. If your bank does not provide you with an interest rate higher than the inflation rate? Change your bank now! If you don’t you’re actually losing money every day.

Student Loans Company
Government WWII Debts
MoneySavingExpert – Should I Pay Off My Student Loan?
Bank of England (Inflation Rate Information)

*It’s not strictly true that they are not making money from these loans. You see, the inflation rate (RPI) is set by the Bank of England on a monthly basis but the SLC inflation rate is set annually (March of each year). If the rate is high when the SLC rate is set and then drops dramatically (as it did in the 2005-2006 academic period) the loan is increasing at a rate higher than that of inflation because interest is charged daily on the SLC loan.
What does this mean to you? Just make sure that your bank is paying you interest over the rate of inflation (as set in March of that year) and you’ll be OK.