Posted by Flora Maudsley-Barton | November 24, 2012
Another broken rung on the property ladder
I helped out Independent on Sunday recently with its Wealth Check about Rove Mejia – an employee with a student loan – saving up to buy a property.
The case study made me think about the impact of debt on our young professionals.
Borrowing the maximum for a three year course produces a debt just of £50,025. The repayments are £74.58 per month in this example (Rove earns £28,000). That doesn’t sound too bad, but those payments are predicted to last well over sixteen years. This affects how much graduates can borrow, for a long time, in two ways.
1 – Debts reduce mortgage capacity
You may be aware that when you take out a mortgage, any ‘ongoing’ financial commitments are deducted from your income. In our example, the repayments go up over time, from £895 to £7,672 per year. Repayments also go up when you get a pay rise above inflation, capped at £35,000.
It’s not surprising that mortgage lenders need to take that into account – it would hardly be ‘responsible lending’ to disregard that debt. Fundamentally, the student loan repayment is an effective pay cut of at least the starting repayments.
It’s not quite a ‘blank cheque’ because the payment is capped at almost 4.9% of gross income. That’s really 6.5% after tax. In short, a long-term liability.
2 – Inflation doesn’t help here
Normally, if I take on a sixteen year loan, I don’t need to worry about the future costs, because I expect my earnings to rise with inflation. Over time, I expect my income to rise so that £74.58 repayments take up an ever smaller share of my pay.
But. My Student Loan Company interest rate is set at the lower of the Retail Prices Index or 1% above the Bank of England base rate. This means that my payments will increase when inflation increases because the cost of repaying the loan is linked to inflation.
In short, a long-term real liability. Even more worrying, for imminent graduates, is the realisation that a sustained period of fairly high inflation would help get rid of our budget deficit.
For me, this proves that debt is never healthy for good financial planning. I have heard the argument that it’s worth taking the student loan because the rate is so low. I’ve never been in favour of this. This real-life example demonstrates some of the hidden pitfalls.