Student Debt and how to deal with it
by Stephen Dwelley
Mortgage and Personal Finance Expert 
Key points about student loans
Student loans have been with us for over 15 years and there are currently more than 2.6 million borrowers with the Student Loans Company with debts still outstanding. The burden of this debt for new graduates will continue to increase with the trebling of annual tuition fees to £3,000 in 2006/2007 and with further increases expected in 2009.
The Student Loan Company charges interest in line with the retail price index and is therefore an undoubtedly cheap form of finance. However, even with repayments which are set at 9% of income above £15,000, these loans are going to take many years to clear. Indeed, for a graduate earning £20,000, whose income increases at 4% per annum, it will take some 13 years to repay a student loan of £10,000 and 21 years for a loan of £20,000. This is clearly going to have a long term effect, especially during the early years, when graduates are seeking to get on the housing ladder and would also be well advised to start saving for their pension.
Previously some graduates have had a somewhat cavalier attitude to repaying student loans, as prior to 1998 repayments were taken from their bank accounts not as an attachment to earnings. The level of non-payment has now risen to the extent that the Student Loan Company is asking for the Government’s permission to register these defaults with the credit reference agencies. If this is granted, which seems most likely, it will mean that the defaulters will find it harder to obtain mortgages or other forms of credit.
Dealing with debt
So faced with this debt, what can be done to try and reduce the longer-term effects? Firstly, it should be appreciated that as loans go the Student Loan is a very cheap one in terms of the interest charged and is therefore unlikely to be bettered, unless parents are willing and able to offer an interest free loan. Certainly, if you are also burdened with credit card debts, these should be the first to be repaid. However, be very careful in chasing 0% deals by changing cards frequently, as this can have the unintended effect of reducing your credit rating.
You should also remember that debt is one part of the personal financial jigsaw and another sensible course of action is to try and build up assets rather than dissipate income, so improving your overall position for the long-term. Of course, this is easier said than done, particularly in the early years after university when there may not be much cash left to save after the bills (and social life) have been paid for. However, all graduates need to put a roof over their head, so one way young professionals could build up asset wealth was by owning property rather than renting – which many young people regard as money down the drain. Graduate Network therefore introduced the ‘share to buy mortgage’ for friends buying property together as one way to facilitate graduates getting on the property ladder as soon as possible. The major advantage being that after 5 or 6 years renting you have gained nothing, whilst for a similar monthly outlay on a mortgage and some modest increase in property prices you could have built up some useful equity.
The area of pensions is another where a few pounds invested early on can save having to invest a great deal more later in life. If you are fortunate enough to be an employee of the state, a ‘gilt-edged’ pension usually comes as standard, to which you will contribute 6% of your income. However, for those employed in the private sector, where the employer does not offer much in the way of a pension, you could consider an arrangement known as ‘salary sacrifice’. An employer’s costs also include National Insurance payments of approximately 12.8% of salary. If you were to ask your employer to pay you £1,000 per year less and the employer paid this into a pension for you instead, then they could also pay in the national insurance saved at no cost to themselves. Therefore a contribution of £1,128 could be made but the actual cost to you is: - £1,000 less tax at 22%, less 11% employees National Insurance, less 9% student loan repayment = £580. Investing £1,128 for the cost to you of £580 cannot be bad value.
Will student debt affect my ability to get a mortgage?
All mortgage lenders will take into consideration existing loan repayments in deciding how much they may be prepared to lend. This may involve various types of credit commitment such as car finance, credit cards and personal bank loans as well as student loans. If a loan has less then 6 months to run, then it may be ignored.
To take a fictitious example (but one rooted in our day to day experience). Sarah is 24. She is a trainee solicitor earning £20,000pa. Her credit commitments consist of:
· £50 per month paid to her student loan.
· £150 on a car loan of £5,000.
· A credit card with an outstanding balance of £2,000.
For each of the loans, the lender is likely to take the monthly outgoing, multiple it by 12 to take the annual amount and then deduct that from her income. Thus, with £200 per month going out on loans this means that her income will be reduced by £2,400 for mortgage purposes. With the credit card balance, most mortgage lenders will take 5% of the balance as the monthly ‘outgoing’ and once again multiply this by twelve, so in this case 5% is £100 and this takes a further £1,200 off Sarah’s income giving her a total income after her commitments of £16,400. This is the figure that most lenders will generally use to calculate what Sarah could borrow.
Thus, it will be seen that it is generally the level of monthly repayment not the size of the debt that will ultimately dictate the amount of mortgage that may be obtained. However, many lenders are now changing to a system of credit scoring to calculate the amount they will lend an applicant and this will often reduce the effects of student loans as these repayments can be held in abeyance if your income falls below a certain level. Indeed, some lenders are prepared to offer quite high multiples of salaries as most twenty-something graduates will be well qualified; have no dependents; be in professional employment or at least in a career with the prospect of rapid earnings growth, and these factors may counter-balance the negative impact of student debt when applying for a mortgage.
Further help
Whatever your situation, the most important point is not to put off dealing with debt if you feel that it is getting out of control. There are various services available for counselling people with debt problems, such as National Debtline:
http://www.nationaldebtline.co.uk/. Alternatively, contact the National Union of Students: http://www.nusonline.co.uk/. The Government offers the following general advice and information on direct.gov for people experiencing debt-related problems.
The material in this article is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions.
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