Industry Leaders and Conservatives contemplate commercial rates for student loans
I was a little annoyed by the recent call by the industry leaders and the Conservative policy of selling the student loan book which will mean in practice students paying the equivalent of a commercial rate of interest for their loans at University. Currently the rate of interest for a student loan is set at around the rate of inflation – so assuming inflation gets back to a more normal rate over the next few years the long term loan rate will settle at around 3 to 5%. Although this seems high it is the cheapest way to borrow money to pay for a course and in effect a student will be paying back at purchase power parity. The value of the money paid back is at the same purchase value at the money drawn now.
Actually the interest rate due on loans fell to a negative number – 0.4% recently so at least in theory the principal was being reduced but the government fixed the minimum rate at 0% which sounds great but means that in these deflationary times the loan principle remains fixed and not reduced in line with the notional purchasing power.
One of the justifications for the student loan system was that graduates over a working lifetime would earn substantially more in salary – currently this is being mooted at around £100,000 over a non graduate. This looks like a substantial figure but when the time value of money is taken into account it seems not so much of a justification and when commercial loan rates are taken into account even less so.
The value of money depends upon its timing – money in the hand now is worth much more than money in 20 years time. Over time the value of money is reduced by inflation or by interest charges. For example a shopping basket in twenty years may cost around £45 more on a hundred pound basket of goods just to account for a 4% annual inflation over the time. This means that a £145 basket of goods can be valued at £100 at today’s prices. Similarly higher salaries are spread over the working lifetime and extra cash as a result of your degree can appear in twenty or thirty years time and be worth much less in today’s terms than you might expect.
Lets assume a student loan of £20,000 at the end of a course and treat this as an investment to achieve extra cash flow over a non graduate person each year over a forty year period of £2500 (£100,000 divided by 40). On a discounted cash flow of this money stream at 4% interest the breakeven is some 13 years away and the total value of the £100,000 at today’s prices is about £45,000. In other words for the loan of £20,000 it is paid back and you make £25,000 return on your investment over someone who did not bother. Behind these sorts of figures is the sad fact that most graduates will end up in jobs that pay no more than a non-graduate and will thus never get the return.
The situation is worse if we go along with the hare-brained idea to charge students a commercial loan rate currently at 8%. If we assume a 10% average interest rate over the forty years we are talking about breaking even on the investment in 25 years and the value of our £100,000 coming down to £20,000 at today’s prices. This sort of benefit is so far down the line that in investment terms in a business such a proposal would be thrown out.
We often are taken in by large sounding numbers that materialise years away (remember the endowment fiasco) and forget to account for the timing of the investment or the probability that we can cannot achieve it per se. Most graduates will have rather routine jobs that a generation ago were handled by A level high school leavers and the rewards for others may be years away whilst they find their feet. Training graduates is a long term investment for this country in ‘its’ intellectual capital and should be treated as something that will benefit society as a whole and help us stop or even reverse the long term decline in our global position as a trading nation. University education should be available to those who can do it in a grant maintained format without burdening young people with debts that take years to pay off in exchange for dubious long term benefits.