University fees: Why paying tuition and living costs upfront might not be the best financial strategy

With A-level results out next week, many students will be looking towards the next stage of their education – the university years.

But as the cost-of-living crisis heats up, students set to start their studies this Autumn or in the years to come may be feeling anxious about the cost of a university education – with their parents even more nervous if they are planning to cover that cost.

While most families do not want their children to graduate saddled with debt, helping to fund a university education, whether it’s support with the fees or living costs, might be a step too far in these financially constrained times when households are already facing a long winter dogged by rampant inflation, soaring energy bills and higher living costs.

But before parents and students panic, Alice Haine, personal finance analyst at investment and coaching platform Bestinvest, says paying tuition fees or living costs upfront, or overpaying after you graduate, might not be the most-sensible financial strategy – whether there is a cost-of-living crisis to account for or not.

“While the fear is that enormous interest payments could balloon a loan to unmanageable levels, the reality is that many people will never repay the full amount.

"This is because the repayment rate depends on a graduate’s salary and when they took out the loan. To give you an example, students that started their studies in the 2021/22 academic year and borrowed to finance their degree years are expected to finish their course with an average debt of £45, 800[1], according to official data.

“The Government only expects about 20% of full-time undergraduates to repay that debt in full, so labelling the student loan system as debt is a bit of a misconception. Yes, students effectively take on debt at a subsidised rate to cover their tuition and living costs but how much of those loans they end up repaying depends on how much they earn.

“What you owe and what you repay can be two very different numbers, so perhaps it would be wiser to think of student loans as a graduate tax, as the amount you pay increases the more you earn in the same way income tax does.

“If a graduate never earns more than £27,295 during their career, then they will repay nothing under the current system. Earn over that amount and the repayment amount is set at 9% of everything they earn over £27,295.

“However, changes are afoot. A reformed version of the system will start from 2023/24, when the average debt at the end of a typical three-year period is expected to fall to £43,400 [1], but with the repayment rate rising to 55%. This might encourage more families to consider helping their children repay.”

Here. Alice Haine explains why parents might want to hold off before dipping into their own savings to pay a child’s tuition fees and living costs upfront – and whether they want to adjust that thinking when the reformed system comes into play in September 2023.

With the threshold differing depending on the type of student loan you hold, known as a plan, and whether you are an undergraduate or postgraduate, when you started to study and in which part of the UK, for this analysis we will focus on Plan 2 – which applies to most England and Welsh students starting an undergraduate course since 2012.

At the end of March 2022, the value of outstanding student debt reached £182 billion[1], with the Government expecting that figure to reach around £460bn at 2021-22 prices by the mid 2040s.

Look back at the history of tuition fees and just a generation ago students did not have to consider the tuition cost of their studies at all. Tuition fees were first introduced in 1998 with an upper limit of £1,000 per year. This rose to £3,000 in 2004 and today they are £9,250.

Over a three-year undergraduate course, that equates to £27, 750 but students or their parents don’t need to have that amount in ready cash before they start university to fund this. Instead, a student can apply to the Student Loans Company (SLC) for a Tuition Fee Loan, which is paid directly to the institution.

As well as the tuition fees, there are also living costs to consider, with a Maintenance Loan also available from SLC to help cover those – however, this loan is means tested, which means parents of children under the age of 25 may also need to stump up for some of the costs.

The amount you can secure under the living loan depends on whether a student lives at home or away from home, with those in London receiving a further bump up, as well as the annual income of your parents. There are some caveats to that such as if someone is eligible for benefits or whether there is one or more dependent children in the household.

Those living away from home and living outside London for the 2022/23 academic year can receive a maximum living loan of £9,706, but depending on their parents’ income, they might only receive the minimum of £4,534 with their parents expected to make up the rest.

Parents earning less than £25,000 don’t need to contribute anything, for example, while families with a combined income of £60,000 need to contribute £14,520 in total over a three-year course, with the parental contribution maxing out at £18,660 on earnings of roughly £70,000 depending on whether the student lives at home or away.

Parents will have to supply financial details for the last full tax year before the start of the academic year, so for the 2022/23 academic year, that will be the 2020/21 tax year.

Of course, there’s no guarantee parents will stump up the cash so the student might have to find other ways to supplement their income such as through a part-time job. It is also vital students learn how to budget to ensure their money lasts the full term, not just the first few weeks.

For the over-25s or those that have been supporting themselves for at least three years before university, they can declare themselves independent to secure the highest amount possible.

With the maximum loan sizes set at £9,250 for the tuition fees and £12,667 for a maintenance loan in London the 2022/23 academic year for a student living away from home, some people could leave a three-year degree course with £65, 750 to pay back. But remember, that is the potential amount they have to repay, and this is where it all gets interesting.

Graduates that started their studies in the Autumn of 2022 only repay their undergraduate student loan once they earn above £27, 295 a year – the equivalent of £2,274 a month, with the repayment amount fixed at 9% of everything you owe above that figure. That rule applies to all earnings from your regular job, whether employed or self-employed, as well as earnings from investments or savings accounts.

As an example, someone earning £30,000 a year pays 9% of the £2,705 above the threshold level of £27,295, which equates to £243.45 a year.

If you earn £40,000 a year, that 9% applies to the difference of £12,705 between your salary and the threshold – that's £1,143.45 a year, with this money automatically deducted from your salary by your employer. That is a slightly chunkier amount to consider, but if you only hit that salary 25 years after you graduate and your salary is pretty static, with only five years of repayments to make it is more cost-effective to just pay the monthly loan repayments when you are required to.

Hit that figure straight after graduation, however, with a career likely to deliver hefty pay rises and your strategy might change dramatically – with it making more sense to clear the debt entirely (particularly if your family are willing to help) or to overpay to clear the debt quicker and reduce the interest rate charges applied.

Therefore, paying tuition fees and living costs upfront or overpaying on the repayments once you graduate only makes sense for those who will become high earners. But how many students at university can look into the future to see what they are earning? None.

While you are studying the loan accrues interest; this is made up of the Retail Price Index plus up to 3%, with that rate applying until April 5 of the year after you finish or leave your course. After that the rate depends on your income in the current tax year.

Source: Gov.uk

For those earning under £27,295, the outstanding balance simply accrues RPI inflation, which currently stands at 1.5%, which is based on the March 2021 rate.

For those earning more than that amount, the interest rate gradually rises the more you earn, going from just RPI to RPI with up to 3% added on top at a rate with the 3% ceiling coming into force once you earn £49, 130 a year.

To give an example of how interest inflates what you owe, someone with a starting salary of £55,000 in August 2022, will repay £95,790 back over 25 years on a total loan of £54,582, assuming 3% inflation and graduate earnings that grow at inflation + 2% per year [2].

Note, however, that the interest rate students pay changes every September and links back to the RPI of the previous March. With RPI inflation standing at 9% in March 2022, it means that students would potentially have an interest rate of up to 12% applied to their loans from this September. However, the Government initially capped the interest rate at 7.3% earlier this year before lowering it again to 6.3% this week.

While higher interest rates might prompt more students to overpay to reduce the total sum they have to repay, again, this does not always pay off.

For a student that never earns above the £27,295 figure, the loan will be wiped 30 years from the first April after they graduate, so it would be pointless overpaying. In this scenario, the loans effectively become grants that paid for a university education as they used to in the past.

That’s why the system can be particularly appealing for older students, those aged 65 and over, because the likelihood of fully repaying is slim as they may die before the 30-year limit is breached and a debt cannot be passed on to beneficiaries. The debt is also cleared if you are permanently disabled and therefore unfit to work.

For those on incomes higher than the threshold, the decision on overpaying depends on how high your income goes and when that happens. Those earning between £27, 295 and £50,000 will probably only repay part of the debt back, particularly if they only hit the threshold part way through their career.

It is only higher earners that are likely to pay back the full amount they borrowed and the accumulated interest. For them, overpaying can make sense.

In the future, more graduates will pay more of their student debt back. This is because on April 6 this year the government froze the threshold for those that started an undergraduate course after 2012.

The threshold typically rises in line with average annual earnings, so it was due to go up by 4.6% this year to £28,550, but because it was frozen, it means more people may have to start repaying their debt sooner as their incomes rise. The only good news was that tuition fees were also frozen at £9,250, so for now new undergraduates won’t have to borrow more.

Another major factor is the reforms set to come into play for new borrowers starting courses from 2023-24. These include:

• The student loan interest rate will be set at RPI+0% to ensure graduates no longer repay more than they borrowed in real terms – this equates to a cut of up to 3 percentage points
• Tuition fees will remain frozen at £9,250 up to and including the academic year 2024 to 25, so combined with the lower interest rates, the Government said this could reduce a student’s debt by up to £11,500 at the point at which they become eligible to repay.
• The repayment threshold when graduates start repaying their student loan will be set at £25,000 until 2026-27 for new borrowers starting courses from September 2023.
• The repayment term will also be extended to 40 years from 30 for new borrowers from September 2023.

With graduate salaries on the rise - in 2020, the average salary for a graduate aged 21-30 was £6,500 higher than for a non-graduate, according to official data – it means more graduates are likely to repay their loans, so more consideration needs to go into that decision, particularly as the repayment timeline has been stretched.

Again, there is still a chance you will never repay the money in full if your salary fails to rise above the new threshold of £25,000 or only reaches it part way through your career.

Overpaying after graduation makes sense for high-earning graduates with salaries upwards of £50,000 because they will have to pay it all back anyway and early payment reduces their exposure to high interest.

And paying the full fees and living costs upfront certainly makes sense for the very wealthy who can afford the sums involved and avoid the questions of debt and interest altogether.

But no one has a crystal ball on how much a graduate will earn during their career. For parents that want to contribute, one strategy they could employ is to get their children to apply for the maximum loans possible and then help them out with repayments once their salary hits the repayment threshold.

This gives parents more time to build up a lump sum of cash to cover the cost, or even better, more time to invest their money to clear the loan early if the graduate starts on a high salary.

Graduates looking to overpay could also consider whether it is better to direct that money towards investments or a Self-Invested Personal Pension. Building up savings and investments might be more sensible than repaying a debt you may never have to repay.

Notes

[1] Student Loan Statistics, House of Commons Library, published July 19, 2022.

[2] According to figures from Money Saving Expert, July 21, 2022.

By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article.

This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication.

Investment does involve risk. The value of investments and the income from them can go down as well as up. The investor may not receive back, in total, the original amount invested. Past performance is not a guide to future performance. Rates of tax are those prevailing at the time and are subject to change without notice.

Clients should always seek appropriate advice from their financial adviser before committing funds for investment. When investments are made in overseas securities, movements in exchange rates may have an effect on the value of that investment. The effect may be favourable or unfavourable.