Case Study - How much will my Professional Studies Loan cost me?

Thomas is a 27-year old graduate who has received an offer to begin a 5-year medicine degree beginning in September 2006. After working out his budget, he decides he will need to borrow £20,000 to cover fees and additional living expenses during his studies. His bank offers a Professional Studies Loan with the following conditions:

• Annual Percentage Rate (APR) of 5.6%
• 1% arrangement fee
• The full loan amount must be taken straight away
• Life insurance is required at a cost of £5 a month
• He has a maximum of 7 years after graduation to repay the loan
• There is no redemption fee if he repays the loan early

Thomas takes out the loan in his 1^st year and repays it over the full 7 years allowed. The total loan period is 12 years.

The costs of the loan over 12 years are

£5600 in interest charges over 5 years whilst he’s studying (not making repayments).

He offsets some of this interest by keeping the loan money in a high interest account which pays 5% interest. Because he needs to use some of the money each year, the amount on which he can earn interest will go down each year. He takes £4000 out of the high-interest account each year, so makes £800 in interest on the £16,000 in the account in his 1^st year but only £200 in his 4^th year and nothing at all in his 5^th year.

He earns £2000 in interest on loan whilst studying so the total cost of interest on loan whilst he studies is reduced to £3600.

Thomas pays an additional £4110 in interest charges over 7 years whilst paying back the loan so the total interest paid on the loan over 12 years = £7710

Arrangement fee: £200 (1% of £20,000)

Life insurance payments: £720 (£5 a month for 12 years)

Total cost of the loan = £8630

So how can Thomas reduce the costs of his Professional Studies Loan?

The arrangement fee is fixed and life insurance costs are relatively low. Thomas can’t repay the loan whilst studying but if he can repay the loan quicker after he finishes studying he will save money on interest. On a shorter repayment period, the monthly repayments will be higher but even increasing monthly repayments by £100 will save Thomas about £1000. The table below shows the amount of money Thomas will save if he is able to repay the loan in fewer than 7 years.

There is no early repayment (redemption) fee on this loan – if there was Thomas should first check whether repaying early will save him money by comparing the redemption fee against the amount saved in interest.