How a student loan works
From APR and repayments to securities and guarantors, we take a look at the basics of how a loan actually works, and explain some of the key features you should be aware of when looking to take out a student loan.
What is a loan?
A loan is an amount of money that you borrow and, usually, pay back with interest in the future. Practically all of us will have one or more loans during our lifetime. Loans enable us to have things now that we pay for later. Without loans, many of us wouldn’t be able to purchase certain things like your home (a mortgage is the biggest loan you’re most likely to have), a car, a weekend away before your next pay cheque, or your education.
As a general rule of thumb, you’ll find that smaller loan amounts have a higher interest rate and shorter repayment period, and larger loan amounts have a lower interest rate and a longer repayment period.
Consider mortgages, for example. They are generally large loans, as much as several hundred thousand pounds in many cases. Annual interest rates on mortgages are typically in the 2% to 3% range right now.
At the other end of the scale, you have small loans of around £500 from short-term lenders, often referred to as payday lenders. Annual interest rates on these loans can be anything from around 100% to 1000% or even more.
What is ‘APR’?
When you’re looking to compare interest rates on student loans, you’ll generally see this expressed as ‘APR’, which stands for ‘Annual Percentage Rate’. This is the total cost to you of borrowing the money. It includes the interest rate but also any admin fees or other costs that might be involved in taking out the loan. So it is usually higher than the interest rate alone. It’s important to look at the APR rather than just the interest rate as some loan companies may add on extortionate fees which can increase your overall repayments.
When you see an APR figure, you’ll often find it has ‘fixed’ or ‘variable’ after it. For example, Future Finance loans are currently 11.2% average APR (variable). The term ‘variable’ means that the interest rate on the loan is based on an index so it may go up or down over time. If a loan is fixed the interest rate won’t change. Fixed rates offer the guarantee of a known rate during your repayment period but they can be higher than variable rates, especially at the start of your student loan period.
Secured and unsecured loans
When a loan is ‘secured’ it means the company lending you the money have some security or back-up in place in case you can’t repay the loan. Two very common kinds of secured loan in the UK are mortgages, where your house is the security, or a car loan, where your car is the security. The loan provider might lay claim to your house or car if you can’t make the repayments.
An unsecured loan is where there is no such security in place. For that reason, the interest rates can be higher, because the loan provider is taking more risk – they don’t have anything they can lay claim to should you be unable to repay the loan. Students can struggle to get loans on good interest rates because they don’t usually have any security, such as a house, that they can use against the loan, and because they haven’t had the chance to build up a long credit history, which is another key factor that loan companies consider when reviewing a loan application.
The loan term, or period, is the length of time you’ll take to repay it. For example, Future Finance loans can be repaid over 1 year, as a minimum loan term, or 5 years, as a maximum loan term.
Once you’ve taken the student loan and started repayments you can sometimes extend your loan term, if your loan provider agrees to it, or you can sometimes shorten it and pay the loan back sooner. The loan provider might charge you an early repayment fee for doing so though.
Future Finance loans have flexible repayment features. After graduating you can take 3-month repayments breaks at certain points during your repayment period (though interest will still accrue during this time at a higher rate) and there are no early repayment fees – in fact, you can end up reducing the total interest you pay on your loan by paying it back sooner than planned.
Sometimes you can get a loan provided you have a guarantor. This is someone who is basically a back-up should you be unable to make the repayments. If that happens, they promise to step in and help you out. The loan is still in your name and your responsibility but the guarantor can be held responsible for making the repayments too. In a way, it’s a bit like having a form of security on the loan.
We often lend to students who can nominate a guarantor. It means we can conditionally approve more loans to students. A loan guarantor will typically have to meet certain criteria. For example, with Future Finance loans, the guarantor should be over 25, live permanently in the UK, and have 48 months’ work history and a reasonable credit rating.