When’s the right time to pay off student debts?

SHOULD I pay off my student loan? The halcyon days of interest-free student loans have just ended. And this isn’t all about fresh faced 20-year-olds – if you’re one of the 3.7 million graduates who hasn’t cleared their debt yet, even from 20 years ago, beware.

Last month, the official student loan company interest rate was, at worst, interest-free, and some were even shrinking. Yet, from the start of this month, the tables turned – what you pay depends on when you started your studies.

Pre-1998 students’ loans – now 4.4 per cent,were -0.4 per cent

If you are one of 350,000 graduates who have loans of more than ten years old outstanding, then your rate has gone up a huge amount.

That’s because the new rate depends strictly on the rate of inflation in the previous March. In the previous year that was negative, so loans were shrinking by 0.4 per cent. Now you’ll pay this year’s positive 4.4 per cent, ie £440 a year per £10,000.

Post-1998 and new students’ loans – now 1.5 per cent and could rise, was 0 per cent

For the past year, the loan has been interest-free. But from its current 1.5 per cent, it could rise more even before next September.

This is because the rate you pay is rather complicatedly set at the lower of inflation before March (4.4 per cent) OR a measure similar to UK base rates (0.5 per cent), plus one percentage point.

So, if you are one of the 3.3 million graduates with one of these loans outstanding, while it’s currently 1.5 per cent or £150 a year per £10,000 of debt, if UK interest rates rise, so will the amount of interest you are paying, up to a maximum 4.4 per cent.

Should I pay off my student loan?

Now millions are paying interest, it’s hardly surprising that I have been bombarded with emails from people with spare cash asking if they should use it to pay off all or part of their student loan. So you may be surprised to read that, for most people, the answer is a firm no.

To explain why, it’s important to understand why, technically, there is no “real” cost to student loans, as the interest rate is only ever as high as the rate of inflation.

Think of it like this: if you borrowed enough money to buy a hundred shopping trolleys worth of goods, you will only ever have to repay roughly the cost of the same trolleys of goods because the cost of your loan rises in line with prices.

So while the actual amount of cash you have to repay is higher, student loan borrowing doesn’t diminish your purchasing power in any way. This means that while the interest rates may have jumped, they are still the cheapest long-term debt that you will ever be able to get.

Consequently, it’s worth carefully considering whether you should use spare cash to pay them off.

The correct answer depends on your exact circumstances: If you have debts, clear the most expensive ones first. As student loans are such cheap-long term debt, you’d be far better off clearing all other before it.

While this is obvious with credit cards at 18 per cent interest, it’s trickier with super-cheap mortgages.

Yet, remember, in the long run it’s likely the mortgage will be more expensive. Depending on what penalties are payable, it’s probably worth repaying some of your mortgage rather than the student loan.

The main exception to clearing other debts before student loans are 0 per cent credit cards, but, even here, when the 0 per cent rate ends, the APR rate will soar. So unless you are savvy and using a technique called “stoozing” (see moneysavingexpert.com/stoozing), then you are probably best repaying credit card debts first.

If you’re debt-free, you may think clearing the student loans a no-brainer.

Yet first consider whether you’re planning to borrow elsewhere in the future. For example, you may be a recent graduate looking to buy a house or need a loan to get a car.

If so, it doesn’t make sense to pay off your student loan now only to reborrow money again using commercial debt, such as a mortgage or personal loan at a much higher interest rate. You’d be far better off putting your money aside in a top savings account.

Then, when the time comes, use those savings to reduce the amount you need to borrow using a more expensive form of debt.

It’s also worth remembering that student loan debt (with the technical exception of you defaulting on a pre-1998 loan) doesn’t get listed on your credit file, so won’t affect your credit rating.

If you’re debt-free and know you’ll never need to borrow again,you really may be convinced there’s no reason not to pay off your student loan. Well, if you’re one of those on the old 4.4 per cent interest loans, you’re quite right. The cost of the loan is far more than you could earn in savings.

However, that rule doesn’t apply to people on the newer loans, currently only paying 1.5 per cent. If you were to stick the money into a high interest cash Isa (see money savingexpert.com/cashISAs), where you could easily get 2.8 per cent tax-free, you would be earning more interest than the debt costs. In effect, you would be making money out of not repaying the loan.

The only time you shouldn’t do this is if you have no self-discipline and, rather than save the cash, would go on a spending spree and get rid of it. In that case, even though the clinical financial logic isn’t right, the best thing to do is to pay off the debt.

■ TV money guru Martin Lewis runs the consumer revenge website MoneySavingExpert.com. Ensure you get his weekly email so you’re constantly saving money.

Top Tips

New three per cent savings that rise with the base rate

IF you lock up cash for a year, this new savings deal is possibly the best of both worlds. Like fixed savings, you get higher interest for locking cash away, but it’s also guaranteed to rise with interest rates. The Santander Tracker Bond (min. £10k) guarantees to be 2.5 per cent above base rate until it ends in October next year, so it’s currently three per cent. Some existing Santander customers get 0.25 per cent more. No withdrawals are allowed. Full details and daily updated best buys are at moneysavingexpert.com/savings Travelodge winter room sale

TRAVELODGE has released 25,000 £9 rooms, available for stays between November and next January. The usual cost is £29 to £59, so book early for availability. For details, go to moneysavingexpert.com/travelodge