The Inequity of Soaring Student Debt
In October last year Muckler highlighted the double whammy of increasing tuition fees and interest rates applied at levels way above the Bank of England base rate – £50,000 of debt at 18x base rate – loan sharks? No, student finance; he now revisits the subject as rates soar to 6.1%
However unpopular it may have made Nick Clegg back in 2010 when he supported university tuition fees being trebled to £9,000, many students remained sanguine about the fee and loan regime on the basis that they would only have to pay back a student loan when they reached a certain earnings threshold; loans would be written off if they never earned at that level and many may have dismissed the interest charged on the loans as unimportant.
However, whilst this may hold true for many, there are a number for whom the interest rate will matter a great deal; this hike in the rate due to a link to RPI could add years, and tens of thousands of pounds, to their repayments.
Now, leading economic thinktank, the Institute for Fiscal Studies, has said that students from the poorest 40% of families entering university in England for the first time this September will emerge with an average debt of around £57,000.
It said the abolition of the last maintenance grants in 2015 had disproportionately affected the poorest, while students from the richest 30% of households would run up lower average borrowings of £43,000.
Seen by many as a tax on aspiration, current levels of debt are approximately double what a student may have faced before the changes and many will carry the burden of debt with them for decades.
During the 2017 election campaign the Labour party curried favour with younger voters by pledging to abolish tuition fees and help those with existing debt; however ‘unaffordable’ the Tories declared Labour plans, there will be considerable political pressure for the Government to at least make some effort to alleviate some of the burden.
The fact that the Government has frozen the income threshold of when a student starts to pay back their loan at £21,000 merely compounds the problem, meaning that middle earners will pay back an additional £7,000 over the lifetime of the loan.
Figures from the Student Loan Company show that student loan debt has been soaring – up 16.6% in a year – rising above £100bn for the first time, underlining the rising cost of a university education; ironically, universities have never had it so good – university income from teaching is up 25% per student since 2012, and some humanities subjects have seen an increase of 47%.
How does a student loan work?
‘Plan two’ is the name of the student loan regime that has been applied to students starting university since September 2012; interest on their loans starts at the level of the Retail Price Index (RPI) and increases to RPI + 3%.
RPI is one of the two main measures of consumer inflation produced by the United Kingdom’s Office for National Statistics, based upon a basket of 650 representative items, and is typically 0.9% higher than CPI; the rate of RPI in March of each year sets the student loan interest rate from the following September.
A graduate earning under £21,000 pays interest at a rate equivalent to RPI, whilst those earning £41,000 or more pay RPI + 3%, with a sliding scale in between.
When the current system was introduced, RPI was 0.9%, meaning borrowers paid a maximum of 3.9% interest; however, creeping inflation is now feeding through and RPI hit 3.1% in March, meaning that the top rate of interest is now a monstrous 24 x multiple of BoE base rate at 6.1%.
‘the top rate of interest is now a monstrous 24 x multiple of BoE base rate at 6.1%’
As if to add insult to injury, students also pay the maximum RPI plus 3% while they are studying, despite having little or no income, and this rate is maintained until the April after they leave the course; Muckler can see no justification in undergraduates with no income being charged the same rate as graduates earning over £41,000.
The average graduate finishing a three-year course this summer will owe £48,633 which includes £4,980 in interest accrued during their studies; those who take a four-year course will owe £66,659, including £8,455 of interest.
This hike adds more than £3,000 to the balance in a year, meaning that for many their student debt will grow at a faster rate than they are able to pay it back.
Borrowers currently repay 9% of the amount earned over £21,000 meaning that a £51,500 salary would be required just to pay back more than the interest accruing on a loan.
Critics believe the interest charges are exorbitant and are forcing a generation to start adult life ‘on the back foot’; unsurprisingly the Bank of Mum and Dad is being pressed into action as parents have reportedly re-mortgaged their homes or cashed in their pension pots to help their children avoid taking out student loans.
Nathan Long, from Hargreaves Lansdown, said: ‘For many people, if they make the minimum repayments on their student loans, their debts will only get bigger and bigger. Many may never be able to pay them off at all.’
With interest applied to the debt even as the graduate makes repayments, it will be difficult for those on modest incomes to ever reduce their debt; Hargreaves Lansdown estimate that those starting on a not inconsiderable £30,000 salary and achieving good annual pay rises will take 28 years to pay off their loan.
Debts wiped out after 30 years
The Government has said that loans remaining outstanding after 30 years will be written off – leaving taxpayers to pick up the bill, although if that were reneged upon, graduates could well carry this debt well into old age
Through no fault of their own, students will not have worked sufficiently to establish a credit score in their own right and are therefore obliged to accept whatever terms the student loan scheme dictates; the way the interest on student loans is structured keeps borrowers paying for as long as possible.
A Department for Education spokesman told Muckler: ‘Student loans are different from commercial loans, as they are based on income, not the amount borrowed.
‘Interest is linked to RPI to ensure that student funding remains sustainable. On average, graduates enjoy a considerable wage premium. Our system is fair.’
However, RPI fluctuations can add significantly to the debt each year; the more that is earned, up to the upper threshold, the higher the interest gets.
Take the example of a graduate with a £35,000 of debt, achieving a not inconsiderable starting salary in the region of the national average wage – £27,000 a year – and achieving what is currently a top-end annual salary increase of 3.5%.
By most measures, this grad could be considered to have done pretty well for themselves – right?
‘what is clear is that student debt is a burden to be carried by low, middle and high earners alike and a significant drag on those looking to purchase a property’
Based on RPI at 0.9% – the rate at the inception of the scheme – calculating repayments and interest monthly would see them clear their debt in 25 years; total repayments would be around £56,000, of which £21,000 is interest.
However, with RPI at 3.1%, they would just about clear the debt by the 30-year cut-off, having paid back a total of around £82,000.
A graduate with similar levels of debt but achieving a salary of £30,000, would clear the debt after 23 years having paid back £55,000 at 0.9%, but at 3.1% RPI, they would just clear the debt at the end of 30 years – seven years later – having paid a total of £92,000.
These scenarios are illustrative and based upon the rate of RPI remaining constant for the duration of the loan, when in reality the rate will fluctuate, but what is clear is that student debt is a burden to be carried by low, middle and high earners alike and a significant drag on those looking to purchase a property, or navigate the choppy financial waters of later life.
This interest system may have slipped through with little attention at a time when RPI was at historic lows and the focus was on the tripling of tuition fees; however, RPI was 5% as recently as March 2011 and one of the predicted consequences of Brexit is expected to be a hike in the cost of living – yet another blow to those that would have been inclined to vote remain. Had they been inclined to vote.
Admittedly the student loan system is no less transparent than, for example a variable rate loan or mortgage, but Muckler is concerned at the number of students that may have signed on the dotted without ever having been aware of the fact that wildly fluctuating interest rates could add years and thousands of pounds to their repayments.
However, in comparing the mechanics of a student loan to a variable rate mortgage, it should be set in the context of the fact that Yorkshire Building Society has just launched the UK’s cheapest ever mortgage at just 0.89%; that may come as no comfort to those that are never able to shuck off the crippling burden of student debt and for whom home ownership will remian just a pipe-dream.
Future increases to tuition fees are planned to be based upon the achievement of rigorous ‘gold, silver and bronze’ standards of education, but Liberal Democrat leader Tim Farron said a further rise in fees was ‘unacceptable’ and asked: ‘Where does it end?’
‘Higher education needs to be funded sustainably but for Government to continue to let fees creep up year on year, so students are unable to get a clear picture of the debt they might face, is unacceptable’ said Mr Farron.
Muckler can see no justification in undergraduates with no income being charged the same rate as graduates earning up to £21,000”
Having reneged on its promise to not retrospectively increase student loan payments and withdrawing maintenance grants, trust in the Government in this area is unlikely to be high; however, those struggling with student debt may not yet feel able to forgive Mr Farron’s party on June 8th for the role it played in adding to their plight.
One thing is for sure, the decision to take on such a significant student loan is not an easy one and those universities deemed to be in the ‘bronze’ category when grading begins, may well struggle to attract students, particularly to courses that deliver little in terms of employability; however difficult it is to plough a furrow armed only with a BA (Hons) Golf Management, it could be even more so with a fifty-grand monkey on your back.
This is a topic to which we will return because it feels intrinsically wrong, and likely to be more so as inflation becomes more significant; it is certainly time for parents and grandparents to consider some of the options that exist in terms of establishing investment plans aimed at giving children a financial head start.
Many are explored elsewhere on DIY Investor, and those considering an automated solution may be interested to learn of the next generation of automated investment managers – robo-advisers – at sister site Muckle – robo advice
It’s all a far cry from when Muckler gratefully received his beer tokens from the local authority and immersed himself in all of the hedonistic and mind-expanding experiences that university life could serve up – achieving a perfectly respectable ‘Desmond’ along the way.