The £47,000 cost of a gap year as student loan changes hit

AJ Bell press comment – 16 August 2022

• A-level results on Thursday will be a catalyst for students still deciding whether to take a gap year
• Taking a gap year this year will cost the average graduate almost £47,000 extra in student loan repayments under the new system
• New student loan system hits in September 2023 – with 40-year repayment period and lower repayment threshold
• Someone on average graduate starting salary of £24,000 will pay almost £47,000 more under the new system
• But higher earners will benefit from the lower interest rate
• Someone on a starting salary of £40,000 will save £25,000 by taking a gap year

Laura Suter, head of personal finance at AJ Bell, comments:

“A-level results day is a nerve-wracking time for many teenagers, but the ante has been upped this year as the decision of whether to defer your place could make it the most expensive year of your life, with the new student loan system piling tens of thousands more in costs onto some graduates from 2023. Lots of students this week will make a final decision on whether to defer their place for a year, while those who don’t get their university place will have to decide whether to go through clearing or wait and re-apply next year. But the financial ramifications could be huge for those going into all but the highest paying careers.

“Changes to the student loan system mean that anyone who defers their university place from September 2022 for a year (or more) will fall under the new system, which has a lower repayment threshold, a longer repayment period of 40 years before the loan is wiped out and a lower interest rate.

“Someone on an average graduate income who sees a few payrises in their career and leaves university with £45,000 of debt could pay almost £47,000 more just for taking a year out and being pushed onto the new, far more expensive, student loan system. The double impact of the lower salary threshold when graduates have to start repaying the loan, coupled with the extra decade they have to pay off their debt before it’s wiped out, means that from next September many graduates will be stung with far higher bills.

“But those who would win big from taking a gap year are students going into courses that lead to higher incomes. For example, those going into areas such as economics or engineering could save tens of thousands of pounds under the new student loan system. From 2023 the Government has reduced the interest rate charged on loans. Previously it was on a complicated sliding scale depending on how much you earnt, with a maximum of the RPI measure of inflation plus 3%. However, it will now be charged at a flat RPI. This benefits those earning the most, as they will pay off their loan in full under both the old and new systems, but with the new system they will incur less interest before they do.

“Conversely, anyone never earns more than the repayment threshold, either due to low salary for their entire career or working part time, will never make a loan repayment and so won’t be affected by the changes in the system. However, the big bulk of middle earners who will never pay off the debt will face tens of thousands of pounds more in repayments over their lifetimes – leading many to question whether the university degree is worth it. Many will be paying off their debt into their 60s and will clock up 40 years of paying a 9% tax on some of their earnings

“However, it’s almost impossible for 18-year-olds to predict whether they’ll be better or worse off under the new system as it depends what your starting salary is, how many pay rises you get, whether you take any career breaks and whether you work part-time during your career. All of these things impact how much you repay and how you fare against the current system. This head-scratchingly complicated number of factors means that many people just sleepwalk into taking out the loans and worry about how much they’ll repay later.

“For example, someone on a starting salary of £30,000 who sees a few payrises during their career will repay £35,000 more under the new system. But if they started their career earning £40,000 and saw the same pay rises, they’d actually benefit from the new system and pay £25,000 less.

“The changes are a revenue-raising move from the Government who are using future graduates to help plug the gap in their post-Covid finances, and attempting to reduce the amount of student loan debt that’s written off each year.”

Source: AJ Bell. Assumptions: Assumes RPI inflation of 3%, and that the repayment threshold rises by 3% a year from 2024 under the current system and from 2027 for the new system, as per Government plans. Assumes the graduate's salary increases by 3% a year but also has £5,000 payrises in years 5, 10, 15 and 20 of their career.

Source: Department for Education