If “a rising tide floats all boats”, then the reverse can also be true, as famously said by Warren Buffett with:
“Only when the tide goes out do you discover who’s been swimming naked.”
Today my post is for young people in the UK with student loans to pay them down or off as early as you can. The tide is going out, don’t be left swimming naked, please!
I’ll tell a story first, and before that highlight that, since 2001 and the recession post 9/11, we have lived almost all the last 20+ years in a low inflation and low-interest environment. However, prior to that, those of us aged (say) 45+ lived in a different world, where inflation and interest rates were far higher and we had to plan around that. Now, in 2022, we are back there, so there is much to educate people younger than ourselves on. So, to my story and my lessons for today.
I’m 56, and 34 years ago, in 1988, I bought my first property aged 22, with a 100% mortgage and with property prices far lower than they are now, at a price of only 3.5 times my pretty low salary at that time. That same property is now 9x the price it was then, whereas salaries for the same CA apprentice role with the same firm are only 3x as high, things are FAR tougher for the generation coming through now. So, someone aged 22 now has no chance of buying such an entry-level property, not now, probably not for a decade.
Not only do youngsters today have to raise the deposit and then clear the huge “income multiple” hurdle, but they also have crushing student loans to consider.
Back when I was young, I could buy a place as I had left university with no student loans as a) we did not pay university fees then, plus b) we received a grant for housing. I then simply topped things up by working a weekend job and finishing university with a small overdraft, and no loans. In 2022, though, it is typical in the UK to leave University with a loan upwards of £50,000, and, to make it worse, students are told that “they only have to pay the minimum” and that if their loan is not fully paid off thirty years later it will be written off. When you are in your early 20s, thirty years feels a long, long way away, so it is very difficult to convince a recent graduate to pay down their loan early if they can raise the money, not least as they need to save for a deposit on a future property purchase.
Two problems here. First, student loans are at high-interest rates so the minimum payment doesn’t normally reduce the principal balance. Second, if your earnings increase as you develop your career, you then do have to pay off the balance, it won’t be written off. The combination can mean you will pay far more in interest and principal than you owed in the first place, and by a horrifying amount!
Now, back to the 22-year-old me buying a flat in 1988. At that time I had grown up in a high inflation environment, so was used to high-interest rates. I did not, though, expect rates to spike just after I bought my flat, and wow, how they spiked! At that time the only mortgages I could get were floating-rate ones, so when rates spiked to over 14% for a few months any reserves I had were gone, evaporated. I was totally stressed and my monthly outgoings were far more than I could afford, I had to scrape by and beg my bank for an overdraft extension, which they (just!) gave me for a time. That was a learning I have taken with me always, both to be prudent around saving reserves, and also the value of paying down loans where I can.
Now, back to the present day. Last month this article: “Graduates to be hit with ‘brutal’ student loan interest rates of up to 12%” highlighted the savage combination of the already high student loan interest rates allied to the recent huge spike in inflation rates, as, yes, student loan rates are also linked to the rate of inflation.
Whilst I find the whole system reprehensible, that is another topic. Today let me just address any recent graduates that have any spare funds they can allocate to save or to pay down loans. First, do what you can to have some reserves for when the tide may go out. Second, if you can do that, then after that consider that before investing in other options to save for your future, recognise that if you are paying off a high-interest graduate loan, that is a GUARANTEED return of the interest rate on the loan. In savings, the highest guaranteed return you can get is on a savings account or similar and currently you can get a 1% or less return. Student loans, however, are now at such high rates that your (yes) GUARANTEE returns are far, far higher.
This has been a post dedicated to the financial literacy and empowerment of our youth. If you too can help young people with this, please do, they are simply not taught this in our education system!