If you’re a parent, it’s natural to want to help your kids out financially. Parents of graduates, in particular, have a dilemma.
You might have saved a nest egg, received an inheritance, or taken 25% of your pension as tax-free cash. It can be tempting to use those savings to help your kids reduce their student debt, but should you?
On one hand, you might want to help your offspring start adult life debt-free. But on the flip side, you might want to focus on paying off your own debts like your mortgage.
Before making a big financial decision, it’s important to understand the benefits and considerations to both.
Understanding the basics
Mortgage rates have been steadily climbing over the past two years, hitting a 16-year high when interest rates rose to 5.25% in August 2023, before falling back to 5% in August 2024. For many homeowners on variable rates, tracker mortgages, or for those needing to remortgage, this means paying more.
The benefits of paying your mortgage off early are well-documented. Most importantly, you can reduce the total interest paid, saving thousands of pounds. Psychologically, being mortgage-free offers peace of mind, especially as retirement approaches.
Students, meanwhile, typically graduate with about £45,600 of debt, according to the Student Loans Company (SLC). But student debts aren’t like other debts; they’re generally considered low-priority due to the income-contingent repayment structure.
Anyone who started university after 1 September 2012 is likely to have a Plan 2 student loan. Although the interest rate on this type of loan now stands at 7.3%, the interest rate is irrelevant for many graduates who’ll never repay their full loan.
Graduates only start repaying student loans when they earn £27,295 a year (£525 a week or £2,275 a month). Repayments are a percentage of earnings above this threshold. Then, after 30 years, any remaining debt is written off.
Graduates have the option to pay extra amounts off their student loan, or the whole amount, whenever they want penalty-free.
The case for paying down your mortgage
In general, the longer you have a mortgage for, the more interest you’ll pay. Paying off your mortgage early can save you thousands of pounds in interest.
Let’s assume that by the time your child graduates you’ve already made good inroads into your mortgage debt and you have a balance of £100,000 left to repay over the next 10 years.
Assuming an interest rate of 5%, paying off £50,000 now would save you £21,250 in interest and you’d be mortgage-free five years and seven months earlier than planned. If you could pay the whole £100,000 off now, you’d save £26,880 in interest.
Reducing your mortgage payments reduces your monthly outgoings, freeing up cash for other things. For example, if your mortgage interest rate was 5%, every £1 paid off early effectively ‘earns’ you a 5% return. This might be more than you’d achieve from savings accounts or low-risk investments. Paying it off completely and owning your home outright provides a sense of financial security. This is something many see as an additional asset for their retirement fund, if they wish to downsize later down the line.
The case for paying off student loans
Many parents will be keen to help their children embark on adult life debt-free. Without student loan repayments hanging over them, your kids will have more money to be able to put towards their own home or to pay into a pension.
Graduates who apply for a mortgage will see their student loan repayments factored into affordability assessments, potentially reducing the amount they can borrow.
Graduates with Plan 2 student loans are currently seeing their debts grow by over 7% a year. In comparison, the current average mortgage rate for a five-year fixed rate mortgage is 4.78%, while the average rate for a two-year fixed rate is 5.14%.
So, with mortgage rates significantly lower than the interest on student loans, surely it’s a no brainer to help out your child? Well, not exactly.
Your child’s earning capacity
Before you rush to help out your kids, it’s important to remember that student debts aren’t like traditional loans.
Currently, most student debt is written off by the government after 30 years post-graduation. Newer Plan 5 loans – typically taken out by students who started their course after August 2023 – won’t be written off until 40 years after graduation.
Interest rates on student debt are variable and depend on graduate earnings, ranging from the Retail Price Index (RPI) to RPI +3%. But it’s important to understand that the interest rate doesn’t actually affect loan repayments. It’s how much graduates earn that matters.
Graduates currently repay loans at a rate of 9% of everything they earn above the repayment threshold (currently £27,295 a year). This threshold figure will begin to increase annually by RPI from April 2025.
If a graduate with a Plan 2 loan is earning £30,000 a year, that’s £2,705 above the current £27,295 threshold. Repaying 9% of this equates to £243.45 a year or just over £20 a month.
Research by the Institute For Fiscal Studies (IFS) suggests that 83% of graduates with English student loans won’t clear their debt within 30 years. In fact, most graduates won’t come anywhere close to repaying the full amount they owe including interest.
There are a lot of variables when considering whether your child will be in the minority, with earning potential meaning they’re likely to pay off their entire debt. Perhaps they’re in a well-paying profession now, but how can you be sure that their high earnings will continue for the next 30 years? What if they opt for a career change or take time out of work to start a family and their income changes?
What about your pension?
Some parents might be tempted to use money from their pension to help out their children. But there are a few things to consider before doing so.
Most people with a workplace or personal pension can take 25% as tax-free cash from the age of 55 (rising to 57 in 2028). The rest will be taxed as income. It’s important to keep in mind that as soon as you start withdrawing from your pension, you’re immediately reducing both the value of your pension pot, and the potential for investment growth.
Leaving the money invested for longer means your total pot could be larger and the amount of tax-free cash available later on could ll be larger too. Plus, the longer your pension is invested, the more time it has to benefit from compound interest and potential investment growth.
Before dipping into your own future savings to help your children out, it’s important to consider how much you might need yourself when you stop working. And more importantly, how long the money might need to last you and how to avoid running out. You can take a look at the Pensions and Lifetime Savings Association’s (PLSA) Retirement Living Standards for a better idea of how much you’ll need in retirement.
Summary
The decision between using your own savings to help your kids out is a personal one. And it’s important to consider how it will impact your own income and lifestyle, particularly if you’re approaching retirement. Listen to episode 28 of The Pension Confident Podcast where our expert panel discusses the Bank of Mum and Dad. Watch the episode on YouTube or read the full transcript.
Emma Lunn is a multi-award winning Freelance Journalist. She’s written about personal finance for 20 years, with a career spanning several recessions and their consequences. Her work has appeared in The Guardian, The Mirror, The Telegraph and MoneyWeek. Emma enjoys helping people learn to manage their money well, in both the short and long term.
Risk warning
As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.
