Student loans: Good or Bad Debt?
Becoming a student now means becoming a borrower of large sums of money for most, and from 2012 it could be up to £42,000.
However, it’s not all doom and gloom. It’s important for students to know the difference between ‘good’ debt and ‘bad’ debt.
For the vast majority of students, taking out a student loan is absolutely essential. Without a student loan, you would be unable to start or complete your university education. A tuition fee loan is essential for meeting course costs for most students and a maintenance loan is essential for paying your living costs during your studies. For students, repaying the student debt which results from this loan is simply par-for-the-course when it comes to attending university.
However, the idea of totting up huge amounts of debt still proves to be a major worry for many students. In fact, clocking up student debt and making regular student loan repayments to the student loan company long after university may even put many prospective students off the idea of going to university completely.
In one sense, this anxiety over student debt can be seen as understandable. Indeed, on the surface, there appears to be no positive aspects to debt of any kind. In its simplest terms, debt is borrowed money which will always need to be paid back – most often with interest added onto the original sum borrowed.
In another sense, however, the stigma attached to debt, and the fear borrowing often stirs in people, is less understandable. Debt is a common and absolutely necessary aspect of modern life. All major companies and governments borrow money. In order to buy a house, most people will need to borrow money and will plant themselves in debt by taking out a mortgage (look at it as an investment).
Avoiding debt, then, is clearly largely impossible. Avoiding bad debt, however, is not. While getting into debt is very often necessary, not all debt should be considered to be ‘bad’. There are good types of debt and bad types of debt. Instead of seeking to avoid borrowing money at all times, more attention should be paid to recognising good types of debt and avoiding bad types of debt – those debts which will be most likely to lead their borrower into a world of compounded interest rates and a dangerous debt spiral.
Your student loan, then, is sure to plant you in a significant amount of student debt. But should your student debt be categorised as “good” or “bad” debt? This article will answer this question and will allow students – both current and prospective – to gain a fuller understanding of student debt and their student loan.
Let us start by exploring ‘bad debt’. Credit cards and bank loans are prime examples of ‘bad debt’, since credit card and bank loan repayments are often charged at a high commercial interest rate. This rate will most commonly be 6% or over.
Clearly, taking out a bank loan or using a credit card when you are a student is a bad idea. Generally speaking, as a student, your income will always be fairly low, since your studies will always prevent you from working full time. Taking out high interest loans when your income is low will make paying back the high interest on these debts extremely difficult. If you don’t repay these debts, you will soon find yourself in a position where you are paying interest on the interest you originally owed – an extremely difficult state of affairs.
As a student, you should never need to take out a bank loan and be extremely careful if you are considering a student credit card. Indeed, many banks offer student bank accounts, whose features often mean bank loans and credit cards are totally unnecessary. Owen has provided, and points you in the direction of, some great student bank account tips.
Specifically, student bank accounts with an interest free student overdraft make bank loans and credit cards totally unnecessary. Such accounts enable you to borrow money – that is, eat into your overdraft by spending more money than is in your account – without requiring you to pay any interest with your repayments.
You may be wondering why student bank accounts with interest free overdrafts are being mentioned in this “bad debt” section. This is because the 0% rate of interest does not last for ever. As soon as your studies are completed, your bank will begin to charge you a high commercial interest rate on those repayments. This means that the student overdraft turns from good debt into bad debt after graduating (dependent on how you manage your money).
Therefore, while a student bank account with an interest free student overdraft is reasonable and should not be considered to be a direct route to “bad debt,” it also should not be viewed as “good debt.”
If you are confused about student credit cards then you may want to read our guide to student credit cards. They offer 0% interest up to 56 days on £500 spend. This could potentially be good debt if you manage your finances carefully.
Your student loan is the very epitome of ‘good’ debt. When taking out your tuition fee or maintenance grant loan, you become indebted to the government’s Student Loan Company (SLC). Unlike banks, the SLC only ask you to pay this long term debt back once you are earning a specific amount.
The amount varies depending on your start date. For current students this amount is £16,365 (and going up with inflation each year). For students who commenced their studies in September 2012, the amount is £21,000. Moreover, regardless of their start dates, the rate of interest students pay on their student debt is much lower than commercial interest rates. Specifically, this interest rate is one which matches inflation, making the student loan the cheapest long term debt around.
However, the new student loans system could mean that you are charged 3% interest plus inflation.
Student debt is therefore “good debt” because it is a debt repaid at a low interest rate, and you are only required to begin repayments when you are earning a wage which places you in a good position to make these repayments.
Another reason why a student loan is “good debt” is that student debt will never affect your credit rating (failing to make repayments on your credit card debts will alter your credit rate, and this credit rating could prevent you from securing a mortgage in the future). The student debt incurred from your student loan will do no such thing. Click here to check your current credit rating for free.
Your student loan, then, will place you in debt. However, this student debt is “good debt” – that is, a manageable debt. The student loan company will only commence your student loan repayments once you are earning a graduate wage. Moreover, your student loan interest rate matches inflation, making a student loan one of the cheapest long term loans available.
Remember these soothing facts next time you have a bout of student debt anxiety.
It’s important to remember that ideally you don’t want to get into any debt. It’s all about being savvy and knowing what is a sound investment and what isn’t. There are some grey areas in relation to debt and it’s down to you to weigh up the safe or safer options.
If you need any help on debt issues then please email us or contact your local citizens advice bureau.