Last March, when the Retail Price Index (RPI) showed the inflation rate had ticked down to zero, few of us realized it would have any real effect on our money. But because the RPI influences student loan interest rates, a few percent here or there can make a massive difference to students and graduates.
The good news is that because the interest charged on student loans changes every year based on the inflation rate the previous March, students either paid no interest, or actually earned money on a loan this academic year. The bad news is that last week, the RPI - which is used to measure inflation - shot up to a massive 4.4 per cent, which means student loans could be about to get a lot more expensive.
From September, anyone who was a student after 1998 and earns over £15,000 will pay 4.4 per cent interest on their loan or the Bank of England’s Base Rate plus 1 per cent, whichever is lower. So if you have an outstanding loan of £8,000, you’ll go from paying £0 a year in interest to paying at least £120, if not £352.
If you were a student between 1990 and 1997, the news is worse because the rules are different. For the same £8,000 debt you’ll go from earning £32 a year (i.e. your student loan amount will be going down all by itself) thanks to a negative rate of -0.4 per cent interest, to your debt increasing by £352 a year from September if your interest rate soars to 4.4 per cent.
So what can you do now to make a difference?
Order your debts
If you earn more than £15,000 and took your loan after 1998, the government should be automatically taking 9 per cent of anything you earn over that £15,000 before tax. So, if you earn £16,000, the HMRC will take £90, and if you earn £30,000 you’ll repay £1,350 annually off your loan. If that isn’t happening, it’s your job to get it put right or you'll end up playing catch up on your repayments.
But many of us also have overdrafts and credit card loans, costing us far more in annual interest. The average interest rate for a credit card is around 19 per cent and for an overdraft is around 14 per cent, according to the Bank of England.
If your £8,000 debt was on a credit card, you’d be charged a huge £1,520 every year for the privilege, and £1,120 for such a big overdraft. So it makes sense to pay any outstanding debts off here first whenever possible. Your basic student loan repayments will automatically be coming out of your wages every month, so before paying anything extra towards this cheap loan, use any surplus cash to pay off those more expensive loans first.
The best way to free up as much cash to pay off your debts is to create a monthly budget. Start by writing down everything you spend in a month to work out where you could cut down. From that you can work out how much extra money you can put towards paying off your loans.
Set out your maximum spending for everything else and stick to it, and you should be able to pay off your debts far sooner than you thought. If you have savings, the record-low rates of interest you earn there will mean you’ll probably be far better off using the cash to pay off your debts.
Think about the future
Peter Chadborn, of independent financial advice firm CBK Colchester, warns:
"Anyone hoping to buy a house in the next few years will need to think about their debts and savings in a different way.
"It's easy to forget about your student loan right now, but if you want to get a mortgage later, the fact that you have an outstanding loan could go against you when a bank is looking at your take home pay.
"But equally, first-time buyers will need significant deposits for the foreseeable future, and that means plenty of cash savings."
And he offered this budgeting advice for future first-time buyers:
“Start with how much money you want to have saved for a house by a certain deadline, then work backwards from there – calculating how much you need to save every month, and how much there is left to pay off your student debt.”