plonkee money an english-er's thoughts on personal finance

January 18, 2008

why i’m not paying off my student loans early

Filed under: credit and debt — Tags: , — plonkee @ 12:00 pm

graduation

Debt reduction is very popular in the personal finance blog world. Some of my favourite blogging friends are trying to reduce their debt (including being frugal, I’ve paid for this twice already…, single guy money, credit withdrawal, rocket finance, gather little by little, and others).

I have two major debts, the largest is my mortgage which weighs in at over £86,000 (about $172k). The other debt that I carry is my student loan, which originally totalled £12,000 (~$24,000) and is now down to around £9,000 (~$18,000). I’ve got no intention of paying off my student loan early at all.

I took out a loan for each of the four years of my degree course from the government backed Student Loans Company. There are three unusual factors about this loan which lead to me to decide not to pay it off early, they are as follows:

  1. repayments are income contingent – 9% of earnings above £15,000 (~$30k)
  2. if I haven’t paid it off by the time I’m 65, or if I become unfit to work, it will be written off
  3. interest is pegged to inflation

Why do these lead me to not pay it off earlier?

paying off slowly is risk free

The last two features combined mean that if something unforseen happens and I have a much lower income, or I am unable to work, or even if I get stuck in a minimum wage job, my student loan will not hamper my life further. If my income is lower, my repayments are lower, and I won’t be retiring with this loan still over me. It is safe for me to pay the minimum for as long as I like.

paying off slowly makes money

If I continue to pay it down at my current rate, it will take me another 10 years to pay off my whole student loan. At the moment I have about £200 of spare money a month that I could use to pay off my student loan early. If I used this money to pay down the loan more quickly, then I calculated that I could do it in about 2.5 years.

However, I could take that £200 and instead of using it to pay off my student loaninvest it in the stock market tax free via a stocks and shares ISA.

Assuming that there is always £200 plus my student loan payment available per month, either for debt reduction, or for investing in the stock market, that inflation is a relatively high 4.5%, and stock market returns are a reasonably conservative 7%, I would be £1,300 better off investing in the stock market. £1,300 is a lot of money.

disadvantages of paying it off slowly

The only disadvantage I can see is that I don’t get to experience the much vaunted debt-free feeling. I have it on good authority that it’s very satisfying. I don’t know, I’m in this for the long haul, and I think £1,300 will be very satisfying. And over the following 30 years to retirement, that £1,300 (assuming 7% returns) could grow into nearly £9,800. And that’s a very, very satisfying indeed.

what have i really done?

I really am investing £200 in the stock market (in pension and ISA, switching to an ISA only in April), and paying off my student loan as slowly as they’ll let me. Eyes on the prize.

Image by tompagenet.

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