How to escape the student debt trap
By CHARLOTTE BEUGGE
Last updated at 1:43 AM on 18th August 2010
This summer, more than 300,000 young people graduated from university into a hostile economy where jobs are hard to find.
Many have left with debts of more than £20,000. These are sums beyond the comprehension of many parents, educated in the days of full grants and free tuition.
Here, Charlotte Beugge offers six steps to help you and your children tackle their student debt.
1. Work out what they owe
The majority of graduate debt – typically about £20,000 in England and Wales – will be made up of student loans, with smaller amounts owed on overdrafts and credit cards.
The majority will be owed to the Student Loans Company, with former students owing an average £19,740 after a three-year course.
The maximum loan they could have is £28,537.
Many students will owe money to their banks in overdrafts – which can be up to £2,000. Some will also have credit cards and even store cards.
You need to know what interest rate is being charged on these debts. Store cards are likely to be the most expensive, then credit cards (which are slightly cheaper), loans, and finally the bank overdraft – which should be free.
It’s vital to get the whole truth about their debts – and don’t panic. There might be big numbers involved, but it’s a sad fact of student life today.
2. Tackle their take-home pay
The world of work can be baffling for those getting their first proper full-time job.
Most recent graduates may never have paid tax before. And the sad reality of the current economy is that many graduates won’t be able to find work.
This year’s graduates have a fierce fight for employment – with 156,640 chasing 21,400 jobs. To add to their woes, they are also competing with many who finished last summer: an estimated 20,000 of 2009’s graduates are still unemployed.
Unemployed graduates get Jobseeker’s Allowance: £51.85 a week for single under-25-year-olds.
Even those lucky enough to find work may not realise how much tax they will pay.
For example, someone on a salary of £18,000 would be paid £1,500 a month. But they would only get £1,195 a month after income tax and national insurance have been deducted.
For this tax year (from April 6, 2010, to April 5, 2011) everyone can earn £6,475 tax-free (called a personal allowance). After this they pay 20p tax for every £1 they earn.
Once their salary hits £43,875 they pay 40p tax for every £1 they earn above this.
On top of this, workers also pay national insurance. The first £110 a week they earn are exempt. But after this contributions are 11p in the £1. On earnings above £844 a week national insurance is paid at 1p.
The amount of personal allowance they get, but also the national insurance rate, will increase next April.
Check their tax code. It should be 647L. If it isn’t, they could be paying more tax than they should.
3. Don’t forget student loans
If a graduate earns more than £15,000, then from next April they will have to start repaying their student loans.
This will automatically be deducted from their pay cheque by HM R Revenue & Customs, which will pass it on to the Student Loans Company.
Graduates repay 9 per cent of everything they earn over £15,000, so someone earning £20,000 a year would repay £37.50 a month.
They will have incurred interest on their student loan during their time at university.
For this year, there’s none. This is because the interest rate is linked to inflation, which was very low when the student loan calculation was done. But this will change.
Next month, interest rates for loan repayments for the coming year ahead will be set.
It will be set at the lower of March’s retail prices index inflation rate of 4.4 per cent or Bank of England base rate (currently 0.5 per cent) plus 1 percentage point. So it should be this figure of 1.5 per cent.
4. Find the right graduate account
Once studying is over, banks expect graduates to move towards a more adult relationship with the bank – which means an end to interest-free overdrafts.
Banks do this gradually, cutting back the size of interest-free borrowing over the years until graduates end up on the same deal – and same interest rates – as other customers.
For most graduates, the deciding feature of a bank account is how long the interest-free overdraft lasts – and how big it can be.
Banks expect graduates to reduce their overdraft by up to £1,000 a year, which is equivalent to paying back £83 a month.
Set up a savings account or cash Isa and pay this amount in (Aldermore has a one-year fixed-rate Isa at 3 per cent). Not only will it mean the overdraft debt will be repaid in time, but it will start a good discipline of saving.
There should also be a few pounds’ interest at the end of the year when the money is moved across to the overdraft.
Any money not paid off when the overdraft drops is charged an authorised borrowing rate.
The pick of this year’s graduate accounts is RBS. It has three years of interest-free overdrafts, starting with £2,000 in the first year. Any extra authorised borrowing is charged a low rate of 9.9 per cent.
The graduate loan has a reasonable rate of 9.4 per cent.
Sister bank Natwest is also not a bad deal – though the overdraft rate is a flat 17.81 per cent.
HSBC expects graduates to join the real world within two years – an unrealistic proposition for most. Though, it does have the lowest graduate loan rate.
The Santander account is only available to graduates who are working.
Make sure your child keeps to the rules of their new graduate account. If they exceed the interest-free limits without permission, they will only end up increasing their debt.
There are more details on graduate accounts in the table.
5. Now set a realistic budget
Most graduates are not going to be left with much in their pay packet at the end of the month, even though they’ll be earning more than they have ever done before.
Including a student loan repayment a graduate earning £20,000 would only take home £1,273 a month.
Then they’ll be a whole host of other costs for those living away from their family home – one month’s rent up-front plus a deposit, utility bills, food, transport and new work clothes.
It’s unlikely a new graduate will find spare change. But it’s vital they tackle any debts.
They should get to grips with the most expensive borrowing first.
Shift anything on a high rate on to a lower one – use the maximum interest-free overdraft to pay off credit and store cards. If need be, they should take out a credit card with a long interest-free balance transfer period – such as Yorkshire Bank Gold or Natwest Platinum card, which both offer 16 months at 0 per cent.
However, it’s likely most credit card companies will turn them down if they have only just got a job.
If you or another relative want to help out, you could essentially give them an interest-free loan by taking out one of these cards for them, typically as a second card holder.
You will be responsible for the debt. But it can work if you make sure a direct debit is set up to pay the bill.
Even if they can’t repay their credit card debts at once, just paying off a little more than the minimum each month will save thousands of pounds.
If they have a £1,000 debt and only repay the minimum, it will take them 14 years and 11 months to pay off that debt.
In that time, they would have racked up £882 in interest.
In contrast,if they paid an extra £50 a month, they would clear their debt in 18 months.
6. What to do about student loans?
One mistake many graduates make is to pay off their student loan first, simply because it is the biggest debt. But student loans are actually one of the cheapest forms of borrowing that any young person can get.
Moreover, it doesn’t show up as borrowing on a credit record (unless they default), so it won’t affect their ability to borrow from commercial organisations. Only clear this loan once there is spare cash.
But don’t underestimate how long it will take to get rid of a student loan. A graduate earning £20,000 with student loans of £15,000, even if their salary increases in line with graduate earnings, will still be paying the loan back in 2036. However, after 25 years, anything outstanding is wiped off.
Ask Granny’s Pick of the Week