Exorbitant interest rates have turned student loans into a ticking debt bomb

Rachel Cunliffe
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University Of Birmingham Hold Degree Congregations
The government has on its books an exponentially increasing pile of student debt that it knows will never be repaid (Source: Getty)

Today the interest rate on student loans rises from 4.6 to 6.1 per cent.

By comparison, the Bank of England held the base rate at 0.25 per cent last month.

The highest level of interest you can get on a standard easy-access cash Isa is 1.03 per cent. You can take out a 10-year fixed rate mortgage at a rate of 2.49 per cent. And the consumer price index (CPI) measured inflation at 2.6 per cent in July.

Read more: Three-quarters of millennials will never pay off their student loan

So why are today’s students paying over double that for their education?

Unfortunately for this cohort, the interest rates on student loans are not linked to the CPI, but set at three percentage points above the much more volatile retail price index (which hit 3.1 per cent in March).

In addition, interest is charged from the moment the loan is taken out, rather than at the end of the course. Tom Woolf, founder of alternative finance company EdAid, has pointed out that this means students starting this October will have accrued around £6,000 of interest before they even graduate.

This is supposedly countered by the fact that graduates do not start paying back their loans until they are earning more than £21,000 per year – and even then repayments are capped at nine per cent of anything earned above this amount. Remaining debt is cancelled after 30 years.

This leaves both students and the government in a bizarre situation. The interest on these loans is so ridiculously high compared to average earnings that the IFS found that 77 per cent of students on this scheme will not earn enough in their lifetimes to repay the full amount.

A student starting this September on a three year course would end up accruing over £108,000 of interest on a £27,750 loan before it is written off.

This is not an argument against fees in general. Tripling tuition fees to £9,000 a year from 2012 has actually coincided with the highest ever numbers of applicants from disadvantaged backgrounds, according to UCAS.

Jeremy Corbyn’s misguided election promise to scrap fees would have squandered £10bn on free places for middle-class students, while abandoning poorer applicants, and ignoring the fact that it is far more effective to widen access to higher education by improving schools. (In Scotland, where university is free, students from disadvantaged areas are four times less likely to go to university than those from wealthy backgrounds.)

Requiring students to pay for university isn’t the problem, but the current interest rate and repayment system is madness. The government has on its books an exponentially increasing pile of student debt that it knows will never be repaid.

Already, it has begun to sell this off to the private sector. Although assurances have been made that the repayment terms will not change, graduates are understandably sceptical (especially as a promise to raise the repayment threshold in line with inflation has already been axed).

At some point, one of two things will happen.

Either the system will become too expensive to maintain and will collapse, prompting an overhaul of the way university is funded (a simpler straightforward graduate tax would be a good place to start) – or the creditors will find a way to alter the terms, leaving thousands of graduates with overwhelming debt and interest payments far higher than they were promised when they made the decision to go to university.

It can be hard to feel sorry for students complaining about having to pay for a world-class education, but the current system is both unsustainable and potentially unfair.

It highlights once again the intergenerational inequality that sees taxpayers funding triple-locked pensions in defiance of economic reason, while current and future workers shoulder an increasingly untenable burden.

But as the number of graduates increases, some kind of reckoning is coming. Outrage over the 6.1 per cent interest rate is just the beginning.

Read more: The City is leading the way in providing an alternative to university

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