The 6.1% interest rate on student loans sparks outrage. Rightly so – with a base rate of 0.5% from the Bank of England, charging students 6.1% is outrageous.
But the 6.1% rate is just the tip of the iceberg. Because not only are students charged, but the rate is compounded monthly – a mechanism that results in interest charges starting at £5.17 per day for tuition-only loan borrowers and £12.20 per day. day for borrowers with tuition and maintenance loans, starting April 6 of the year after graduation.
So less well-off students will not only graduate with double the debt of their wealthier peers thanks to the abolition of bursaries, but will also have to pay more than double the interest costs because they have to use university loans. ‘maintenance.
Cost inequity worsens: Compound interest multiplies the cost of living for the less well off as they cover their living expenses with an expensive maintenance loan. A £55 store in the first week actually costs student borrowers over £140 if paid off 15 years later.
Compound interest is different from what many call “normal” interest. Take a loan of £65,000 over 30 years (about three years of tuition fees and maintenance loans). Someone paying 6.1% “normal” interest on £65,000 would pay £3,965 a year, or a total of £118,950 over 30 years.
But when interest is compounded monthly, the interest is added to the original loan amount each month, increasing the loan amount. Monthly interest charges are calculated on the loan plus any prior interest added to it. Each month the loan grows and the interest charges increase: the first month, £65,000 generates interest of £330, which is added to the loan, bringing it to £65,330. At the end of the second month, interest is calculated by reference to the largest loan of £65,330 and costs £332 and so on.
After three months, the £65,000 loan is almost £1,000 higher. Over 30 years, the £65,000 loan grows to £403,329; interest charges amount to £338,329. Compound interest is a great mechanism for lenders.
This £65,000 example shows how monthly compound interest wreaks havoc on student borrowers while rewarding the government lender. In ‘real life’ these figures will be different as borrowers can repay some (or all) of their loans and the interest rate charged is variable until borrowers earn £41,000 (which should go to £45,000 in April 2018, subject to parliamentary approval).
It is clear that the interest rates run counter to Lord Dearing’s fair intention for the student finance system.
“Real interest rates can, however, have the effect of increasing the burden on low-income people,” said the highly respected official, whose 1997 report led to the creation of tuition fees. “With a zero real interest rate, on the other hand, the highest subsidies go to those with the lowest incomes,” he added.
The monthly compound interest rate of 6.1% looks like an abuse of the fair principles established by Dearing and others; principles on which, ironically, the current system is based.
There is now political resistance to reducing interest charges on student loans; however, reducing that rate would only benefit wealthier graduates who would simply pay off their loans faster, some argue. This is a shamefully specious argument, because had it not been for compound interest that would proliferate the size of student loans, such benefits would be greatly equalized.
As Dearing said, a zero interest rate would benefit the less well off more because they take longer to repay.
Worse, this defense ignores the elephants in the room: the cost and impact of mental health issues triggered by spiraling debt; the limits placed on lifestyle and spending in the economy as graduate borrowers attempt to repay exorbitant loan costs, often when they have families to support.
Huge debt impacts the lives of less affluent students far beyond graduation, both psychologically and practically, including with smaller mortgages. Compound interest creates a debt trap, costing all taxpayers, including those who foot the bill for the mental health crisis caused.
Put simply, it is a question of morality: it is immoral to charge children who have just left school a compound rate of 6.1%. A scandal, indeed.
Estelle Clarke is a former City attorney and a proponent of fair student loan terms. She is a member of the advisory board of the charity Intergenerational Foundation and tweets at @legalimportant. His personal website is www.bouncingback.online/.
