Borrowing money for your degree. Why does it need to be SO expensive?

Borrowing money from the government to get a degree is what more and more of us have to do, but the government is asking students to pay exorbitant interest rates on these student loans. Why?

Some loan stats

The UK Government lends about £20 billion to 1.5 million students each year (out of a total of 2.75 million students). The total amount of student loans outstanding was £160 billion by the end of 2021 and is expected to reach £560 billion by the middle of the century. The average student debt is about £45,000, normally to cover the annual £9,250 tuition fee (x3) and to meet some of the annual maintenance costs. Student loans are only available to UK and Irish citizens and European students with settled status in the UK.

How are student loans funded?

Student loans are 45% funded by the taxpayer. To finance the remaining 55% the government must borrow money itself. Governments can borrow at low market rates. Today, the government’s financing costs for Gilts (UK government bonds) are 1.7%, while the interest on student loans has – since 2012 - been linked to the official rate of inflation (RPI)+3%, which would have been 12% (!) for the coming academic year 2022/2023, but was – thank goodness - recently capped at 7.3% by the government. But still…

High interest rates make poorer students

The high interest rates and the aggregate amounts of money they are costing you, become a long-lasting, unhappy, relationship. Say you are borrowing £15,000 each year, you will pay interest from day 1 the loan is made available to you – meaning that you are paying £1,095 in interest in year 1 already (15,000x0.073); £2,190 in year 2 (30,000x0.073) and £3,285 in year 3 (45,000x0.073). During your university years (unless inflation will be coming down) you may have to pay £6,570 in interest alone, an amount sneaking up on you. If, after graduation, you are lucky enough to find a job that pays over £27,295 a year you will then have added monthly loan repayments of 9% of your salary OVER the threshold of £27,295 to your already beefy interest payments.

That students will pay a rate above the government’s cost of financing is understandable as student loans are unsecured and high rates are hence applied across the board. Even if you think of yourself as a low credit risk (aka you do a great degree, you are sure you going to find a well-paid job), the overall ‘presumed student default rate’ is taken on as a portfolio risk. In fact, the government works on the assumption that 75% of student loans are not entirely or never repaid, although - in reality - the repayment percentage is much higher. But this assumption is used to justify the exorbitant rate applied to your loan.

Don’t fret about repayment, say the experts

With average graduate salaries below the repayment threshold of £27,295 for the last 10 years, you could end up not repaying part of the notional amount, but you will nevertheless continue to be charged interest over the total outstanding amount for 40 years after you took out the loan, until the debt is cancelled. That is such a ridiculous long time from now.

The general advice of many personal finance advisors is to not repay the student debt quickly or in a lump sum – even if you were able to do this – as whatever is left of the repayment amount of your loan after 40 years, gets cancelled anyway and no debt collectors will come after you if you can’t pay. Only high earners tend to repay their loans quite quickly (as money is deducted automatically) and lower earners will get away with repaying a fraction or the original loan. This is deemed a fair system. But is it?

Does the government profit from student loans?

The very high interest rates beg the question however if student loans are indeed a government give-away or a cat-in-a-bag? Over a lifetime, a borrower of £45,000 will easily ‘repay’ the total loan in interest, even if earning below £27,295. This is a simple calculation, because when borrowers are required to pay an interest rate at inflation+3%, the government will obviously make a minimum margin of 3% and most likely more, as the government is paying lower market rates over only 55% of the total loan. But even leaving this out, the 3% commission/add-on/margin over £45,000 collected over 40 years (assuming zero repayments) is (£45,000x0.03) x 40 years = £54,000 net to the government. You on the other hand will pay at best double that amount in interest over your lifetime. A lot of money if you look at it upfront.

Creating extra and alternative income sources

Borrowing money for your degree from the government may be unavoidable, but with inflation so high, you are best off to get student loans only for what you really, really need. Consider the loan for what it is, excruciatingly EXPENSIVE. If you can have access to additional sources of funding to keep loans low, do it. Start saving from summer jobs now. Open a junior Isa. Ask parents, grandparents, godparents to contribute (tax free) to your ISA, which maybe your first buffer to reduce the need for maximum student loans. Also, throughout university you can have a part-time job or side gig too, helping you to cover bills and to reduce your interest burden, today and in the many years to come.

Student loans are too expensive in the UK, especially because they are linked to inflation. A fixed interest rate would be fairer to all students and graduates, both ‘rich’ and ‘poor’ and, because of it, create better economic outcomes for all of us.

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