Q My daughter is finishing university in June. She is worried about how to repay the three student loans she has taken out, as she is far from certain she will immediately get a job. As parents we are willing to help, but don't know what's involved. Can you give us any advice?
A There's no need to panic because you don't need to do anything straight away. Repayments on loans made by the state-backed Student Loans Company (SLC) don't start until the first April after a student leaves university. In your daughter's case, that will be April 2008.
However, no repayment at all is due until the borrowers' gross earnings are more than £15,000 a year. Once he or she is earning more than that, the employer will collect repayments of 9% of the amount exceeding £15,000. So if, for example, your daughter gets a job paying £20,000 a year before tax, HM Revenue & Customs will deduct 9% of £5,000, which is £450 a year or £37.50 a month. If she is lucky enough to get a pay rise, her repayments will be immediately adjusted to take that into account.
The repayments are then passed on to the SLC, which provides an annual statement showing the outstanding debt at the end of each tax year. This process is repeated until the full repayment has been made.
Should your daughter decide to work for herself she will be subject to the same repayment criteria, with the same £15,000 gross earnings threshold before any repayment is due. Likewise if she moves abroad - if she earns enough she will still be obliged to repay the loan.
What's the damage?
To find out how much she owes, your daughter should contact the SLC with her account number. The loan to be repaid will include the actual capital amount borrowed by her, including any loan to cover course fees as well as any maintenance loan. In addition, there will be the interest charged on the capital loans and fees, calculated from the date each payment was made during her time at university.
Contrary to what many people think, student loans are not interest free while the student is at university - the interest is simply deferred and added to the total debt. Like any compounded interest, this soon adds up and by graduation the debt may be much bigger than expected.
However, the rate of interest used by the SLC is not linked to the Bank of England base rate or other commercial rates, but to the retail price index (RPI), which is used to measure inflation. The idea is that the student only repays the original
amount borrowed in real terms, allowing for inflation since the time the loan was taken out.
The interest rate is linked to the RPI from September 1 to August 31 each year. Last September, the rate for the 2006-07 tax year was set at 2.4% - lower than the current interest rate.
Although the inflation rate has risen in recent months this does not mean the RPI at the beginning of September this year will be higher than last year. It might well fall back again as a result of the Bank of England's decision to raise interest rates, which is specifically aimed at lowering inflation.
Savings versus repayment
The onus is on the student to repay the loan and severe penalties can be imposed if you try to wriggle out of it without a justifiable reason. Just as with any other borrowing it is an offence not to repay the lender, although the student loan debt is written off after 25 years if there is a genuine inability to repay during that period.
Students are allowed to make direct repayments on the loan if they wish, and as a parent you may want to help out your daughter so she can start her career without a large debt. However, this needs some thought. The cost of the loan, based on the rate of inflation, is very low compared with normal interest rates. It also has undemanding repayment terms based on earnings rather than the amount owed.
It may therefore make more sense to hold any surplus money you may have in a high-yielding deposit account rather than repaying the student loan. You must bear in mind, however, that you will pay income tax on the interest earned from a deposit account - either 20% or 40% for a higher rate taxpayer, unless you opt to save the money in an individual savings account.
Unfortunately, many students also take advantage of the interest-free overdrafts provided by the high street banks. These are not treated as loans with strict repayment dates, but have to be cleared at some stage or heavy interest rates are applied. Different banks have different ways of dealing with students leaving university. Usually they switch the student to a graduate account, which has a special interest rate for a limited period and provision for the overdraft to be reduced in stages.
Banks are eager to retain the student as a lifetime customer, but the interest rates they offer are likely to be well in excess of the inflation-based student loan rate. So dealing with bank overdrafts may be a priority if you want your daughter not to be burdened with expensive debt.