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Debt is a dirty word, so much so that a long time back the financial services industry rebranded it as the much more enticing ‘credit’. But although many of us often called ‘generation debt’ are up to our eyeballs in it, not all debt is created equal, or owed equally urgently. You should not unnecessarily freak yourself out about borrowing money to the detriment of its many positive benefits (your own flat, university degree, iPhone, car, good credit score) or of getting a decent night’s sleep.

Wrapping your head round how to borrow well is also one of the most efficient ways to avoid wasting money, which is why I think it is a topic worth addressing ahead of how best to budget, or start a savings account or pension. There is no point in having money set aside if you are paying out hundreds of pounds in interest on overdraft or credit-card debts because you have not managed to clear them quickly enough.

If you were to borrow £3,000 on a credit card, with an interest rate of 19 per cent (some credit cards now charge interest rates of over 50 per cent), and only make the minimum repayments, starting at £74 a month and reducing over time, it would take you twenty-seven years and seven months to pay it off, and you would have paid an additional £4,192 in interest in the meantime, highlighted the Financial Conduct Authority, the financial services industry regulator. That £3,000 would have cost you £7,192. If you could stretch to repaying £108 a month, by not saving until the debt was cleared, for example, you would get rid of it in three years, and pay £879 in interest. The debt would have cost you £3,879.

I will come on to how best to have and use credit cards, but, having dealt with mortgages, I’ll start with the second-biggest debt you are most likely to be juggling – a student loan. Ironically, that is the debt that should cause the least insomnia. I will then outline the debts that are far more pernicious, and how best to handle them in a way that helps you save money.

If you are mired in really messy debt with a bank or similar lender there are things you can do and people available to help you out of it, so please don’t let it harm your mental health. I have covered this in chapter 11 on money and wellbeing.

Student loans

Putting aside all the controversial politics of whether or not students should have to pay tuition fees, and the rising cost of living at university, you have to admit that student loans have suffered from a shocking PR job. We have all read the news reports about bright young people being forced into £50,000 of ‘debt’ that they will be lumbered with for the whole of their twenties, thirties and forties, at least. While this is technically true, the implications are often misunderstood. The connotations of the dirty D word can be dangerously offputting, especially if you have grown up in a household stalked by debt, or cannot rely on BOMAD to bail you out.

What you need to remember is that with student-loan debt you will never need bailing out. You do not pay anything until you are independently well off enough to do so, whatever your parents’ financial situation, and for anyone who has been to university since 1998 (unless you move abroad to live and forget to inform the SLC) no bailiffs will ever be involved. If you cannot meet your student-loan repayments you will not have to pay them. You can borrow £50,000 and repay zero pounds if you are on minimum wage until your fifties. Martin Lewis, the money-saving expert, describes it as a sort of ‘no win no fee’ education, starving graduate artists and authors excepted.

Banks and payday loan companies, on the other hand, do not give a shit how much you earn. You owe them regardless of whether or not your salary dips, which is why people can get in such a sticky situation when they have borrowed far more than they can ever afford to repay. No win, even more massive fee.

The richest graduates, those that go into banking, City law firms, management consultancy and so on, and can more easily cover repayments, are the ones who will pay off the most, regardless of whether or not they came from a poor background. Obviously this is skewed by wealthy students who have parents that can afford to pay their tuition fees and living costs for them up front, but let’s ignore that for the sake of understanding why you should try not to fear this kind of debt.

Also this is not necessarily the best use of BOMAD, for reasons outlined in the ‘Should I repay my student loan early?’ section below. If there is that much money sloshing about, they should probably gift you a house deposit instead.

I find it most helpful to think about student-loan debt as a tax, or as Martin Lewis calls it a ‘graduate contribution’, that you start paying only when you graduate, and only when you earn a certain amount of salary. CEOs do not lie awake at night in their Fulham pads worrying about how to pay additional-rate tax that is automatically deducted from their salary, though they will potentially owe millions over their lifetime, even if they are unhappy about that fact. Similarly, you should not lie awake worrying about how you will repay your student loan, even if you think it is deeply unfair that it exists.

Like the CEOs and their monumental tax bills, your student-loan repayment will reduce the amount of money you have in your bank account, which will have an impact on how much you can afford to spend on other already pretty unaffordable things like saving for a house. This reduction in income will also impact how much you may be able to borrow in a mortgage, but it will not spiral out of control to the point where you cannot pay it.

Those like me who graduated before 2012 will stop paying the tax sooner than those who started university after 2012, because we borrowed much less. In the short term though, the loans for us older graduates are actually more onerous, because the amount we have to earn before we start paying this ‘tax’ is lower (more details shortly).

What I think is particularly confusing is that interest rates on student loans are, for those younger students borrowing the most, largely irrelevant unless you are a high graduate earner (a City lawyer, one of those CEOs). They could go up to 5,000 per cent and under the current system it would make no difference for many graduates. This is, of course, dependent on a future government not completely changing the system, and no one can predict what may happen, but with the situation as it is now, here’s why and what you actually have to pay.

Need to know: loans for students who started university after 2012, when tuition fees went up to £9,000

You will start repaying your loan only when you earn £27,295 or above before tax (prices true of April 2021), starting the April after you graduate. That £27,295 threshold will rise each year with RPI (a measure of inflation) or average earnings (see the savings chapter 5 for a fuller description of RPI for an explanation of what that means).

Your repayment is a fixed amount, like a tax: 9 per cent of everything you earn above the £27,295 threshold, regardless of interest rate charged on your loan. That means if you earn £28,295 you pay back £90 a year (£1,000 above the threshold, 9 per cent of £1,000 = £90). If you earn £37,295 you pay £900 a year (£10,000 above the threshold, 9 per cent of £10,000 = £900). You can see why higher earners pay more off, more quickly, because their 9 per cent is a much bigger sum. You can also see how much you will need to earn to make any substantial dent in £50,000. Especially because your loan is completely written off thirty years from the April after you graduate – for most undergraduates, when they hit their early fifties. That means an estimated 83 per cent, according to the Institute of Fiscal Studies, of post-2012 graduates will never pay back the full cost of their university days.

Interest is charged on your original loan. While you are studying this amounts to RPI + 3 per cent. It then changes. If you are earning under the repayment threshold, interest is pegged to RPI inflation. For those earning between the threshold and £49,130 as of April 2021 it slowly rises in increments to RPI + 3 per cent for those earning £49,130 or above.

The fact that you accrue interest means that your loan will grow, which means it will take longer to pay it off. But most people will never pay it off in full within the thirty-year time frame anyway. However large your loan becomes – if it were to grow to £100,000 with interest – you still only pay off 9 per cent above the threshold each year. That is why unless you are earning a lot of money you don’t need to worry too much about interest charged, because you only pay off what you can within thirty years.

If interest rises lots, fewer people will clear the loan within thirty years. Richer graduates will feel the pain, though, because they will be paying much more for longer than if the loan were interest-free.

Should I pay off my post-2012 student loan early?

I watched Martin Lewis give an impassioned speech about student loans to a bunch of students at King’s College London in 2018, some of whom told him that they had indeed been worrying about how they could clear their student debt as quickly as possible, because of scary news reports. They did not really understand how the debt worked. He raised two real-life examples of people who had asked him the question of whether they should try and pay a bit off their outstanding loans, which I think explains it well.

The first people who asked him were parents of a girl who had to drop out of university because she was injured in an accident, is now severely disabled, and is unlikely ever to work. They were extremely worried about the debt she ‘owed’. Should they repay her loan from her first year of studying? His answer was an emphatic no. She is unlikely to ever earn enough above the threshold to repay, the debt will be wiped after thirty years, any repayment will be money down the drain. They had no idea, because they had heard only the word ‘debt’, and had already spoken to the Student Loans Company to start to arrange repayments.

Another was a young graduate who had been offered a gift of £10,000 from her grandparents. Should she use it to pay her loan down? Again, probably not. This is because she is unlikely to ever pay the full loan back. If she reduced the debt to £40,000 from, for example, £50,000 and only just managed to clear the £40,000, she would have ‘lost’ the £10,000.

Now what if you expect to earn a lot of money? Presumably then it is worth trying to repay early?

Yes, possibly, because interest rates on the new post-2012 student loans are, controversially, much higher than some interest rates on other financial products such as mortgages and savings accounts, though it might be advisable if you have spare money to get on the housing ladder first, given how much you pay out in rent. It is not an exact science.

Martin Lewis suggests that only those who land a graduate job with a starting salary of £40,000, which then goes up with inflation and decent regular pay rises (no guarantee in this jobs market), should try to repay early to avoid mounting interest. Someone earning £36,000 on graduation, however, with their salary rising steadily with average earnings rise, will only repay about £50,000 of a £55,000 total student loan over thirty years.

This varies of course, because earnings sometimes jump later in life, or you might change careers … there are lots of factors. The Money Saving Expert site has a calculator where you can play with the sliders to see how likely you are to repay your full loan within thirty years.

Need to know: plan 1 student loans, for everyone who started university between 1998 and 2011, and Scottish and Northern Irish students who started after 2012

For those in their late twenties and thirties, like me, your student loan, known as a ‘plan 1’ type, looks different. You will start to repay your loan when you earn anything over £19,895 a year (in 2021–2022). That threshold usually rises each year.

Your repayment is also a fixed amount, 9 per cent, like a tax you pay on everything above £19,895 a year. So earn £20,895 and you will repay £90 a year (9 per cent of £1,000, the difference between £20,895 and £19,895 = £90); £30,895 and it’s £900 a year. Interest rates are lower than the new post-2012 English loans, currently (2020) set at 1.1 per cent. Interest is calculated as either the Bank of England base rate plus 1 per cent, or the rate of RPI inflation whichever is lower.

Should I pay a plan 1 loan off early?

The answer is less obvious than for current students with ridiculous-sized loans, because most graduates will eventually clear their smaller pre-2012 student loans. You therefore have something to gain by doing so sooner, given that your loan is not totally interest-free. Nevertheless the interest rate is, at the moment, particularly low compared with other types of debt and finance, with less frightening repayment terms and consequences. You may find that it is less expensive to clear it at 9 per cent a year and use any disposable income or gift from BOMAD to save for a house deposit or pension, than to clear it and carry on struggling to make the rent. Certainly do not pay off your student loan before clearing other debts where high interest rates and bailiffs are involved.

Which leads us on to the scary types of debt.

Personal loans

If you need an injection of cash, to pay for a wedding, new car, new boiler, holiday, you might take out a personal loan. These are ‘unsecured’ loans, i.e. they are not tethered to anything like a house. A mortgage loan is ‘secured’ against your property: if you cannot pay the bank gets to sell your house as compensation.

If you cannot repay it, however, your debt may be passed on to a debt-collection agency. This is not the same as a bailiff – debt-collection agencies can only request that you repay a debt. Meanwhile interest charges may pile up, so that you eventually have to declare bankruptcy if you cannot pay. A bailiff can come to your property and remove your TV. Bailiffs will only tend to collect debts relating to things like council tax, parking fines or an unpaid TV licence.

Personal loans are more expensive than the best credit cards on the market, but you can usually borrow a bit more with a personal loan, so it depends why you need the cash. With a loan you will normally pay a fixed amount back per month, plus interest over a fixed period of time. It makes sense that the quicker you can pay it back, the cheaper it works out, because interest doesn’t compound as much. For example, borrow £10,000 with an interest rate of 5 per cent for two years and monthly repayments would be £438 and you would pay £517 in interest. For the same sum borrowed over ten years monthly repayments would be lower, £105, but you would pay £2,663 interest.

Personal loans usually range from between £1,000 and £25,000 over terms of one to seven years. These might be sold as ‘home-improvement loans’ or ‘car loans’, but they are the same type of product, just labelled differently. Watch out for fees attached if you repay your loan early, for example, or miss a payment. You might be charged fees for setting the loan up in the first place.

Interest rates on loans and credit cards are advertised with a typical or representative APR. APR stands for the Annual Percentage Rate, and it takes into account not just interest but also any other charges you have to pay, such as arrangement fees, for a loan. The descriptions ‘typical’ or ‘representative’ are there because not all borrowers get the advertised APR. In fact, only 51 per cent of applicants have to receive the advertised APR. How much you can borrow and at what interest rate depends on your credit score. Like a mortgage, the best deals are offered to those with the best track record. If yours is shaky you may be one of the 49 per cent that will not get the interest rates advertised, or you may find you cannot borrow as much money.