The £84,000 cost of a degree

Thanks to a lifetime's interest, students could repay twice as much as they borrow.

According to a BBC report earlier this week, graduates could end up repaying as much as £84,000 over the lifetime of their student loans.

Frankly, as a former mathematician, I am not at all surprised by the BBC's figures.

After all, the twin booms in housing and credit from 1995 to 2007 did a great deal to 'normalise' debt among British adults. Likewise, the launch of the Student Loans Company (SLC) twenty years ago has given millions of young people the chance to spend a lifetime in debt.

Even so, can these calculations be right? Will compound interest cause student loans to double over their lifetimes?

To me, compound interest is a doubled-edged sword, summarised as follows: "Those who understand compound interest are destined to collect it. Those who don't are doomed to pay it."

When it's working on your side, compound interest is a great friend of savers and investors. On the other hand, it's a nightmare for borrowers (especially at interest rates of 1.5% a month or more, as charged by a typical credit card).

Indeed, it's claimed that Albert Einstein once called compound interest 'the eighth wonder of the world'.

A lifetime in debt

Let's take a look at the Beeb's figures in more detail.

But first, note that the following figures apply only in England from 2012 onwards. In Scotland, students pay no tuition fees; in Wales, the Welsh Assembly Government subsidises tuition fees; and in Northern Ireland, a recent report recommended a cap of £5,750 for tuition fees.

From 2012, tuition fees will rise to £9,000 for most English universities. Over three years, these fees add up to a loan of £27,000. However, students also need to borrow money to live, via maintenance loans of between £3,575 and £5,288 a year, depending on their family income.

Mortgaging their futures

Thus, the BBC assumed that, over a three-year course, a student would borrow £4,000 a year in maintenance loans, adding £12,000 to their debt, which now totals £39,000. This is a big enough burden in itself, but when interest is piled onto this loan, it gets a whole lot bigger.

From 2012, graduates will repay their SLC debts by handing over 9% of their earnings above £21,000, for up to thirty years. Thus, those graduates who go on to earn mega-bucks will repay their loans far faster than those who merely make a decent living.

When calculating how much graduates will repay, we need to know how much they earn during their careers, plus the interest charge on their SLC debts. Low-earning graduates will pay only the going rate of inflation on their debts (based on the Retail Prices Index), while high earners could pay 3% above the inflation rate.

Three students, three debts

Therefore, the BBC asked 'leading accountancy firms' to calculate how much graduates would repay under three different scenarios.

Our first graduate starts out on average earnings, but gets a £1,000 pay rise each year. After 30 years, s/he has repaid a total of £78,882, but still owes £14,513. This remainder is written off 30 years after graduation, as is all SLC debt.

Our second graduate starts out on the same earnings, but gets a £2,000 pay rise each year. After 25 years, s/he has completely repaid his/her SLC debt, a total of £83,791.

Our third graduate also starts out on average earnings, but gets a £4,000 pay rise each year. In total, s/he repays £71,873 to the SLC over 18 years.

You can check these calculations by downloading the BBC's Excel spreadsheet.

Saved by inflation (and time)

Of course, these sums look simply huge in today's terms. However, inflation -- the rising cost of living -- eats away at the value of money and, also, the burden of debt. In other words, inflation isn't biased: it destroys both savings and debts.

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Even with inflation running at fairly low levels, a borrower's debts are soon whittled away. After 20 years of inflation at 3% a year, 45% -- almost half -- of a debt will have been 'inflated away'. So, inflation is a friend of burdened borrowers, including students!

Likewise, time itself is on the side of graduates, because any remaining SLC debt is written off after 30 years. Nevertheless, this means that future students graduating at 21 will carry this burden until age 51 -- and, for mature students, even later.

Fiddling the figures

Of course, in order to make higher tuition fees viable, the government had to scrap the current system for SLC debts. Otherwise, the monthly repayments would have become too much of a burden for young adults starting out in their careers.

At present, graduates pay back 9% of their income above £15,000 to the SLC. Therefore, a graduate currently earning £24,000 a year pays back 9% of £9,000 to the SLC, or £810 a year. Under the new scheme, this threshold rises to £21,000, meaning the graduate pays 9% of £3,000, or £270 a year.

That's a reduction of two-thirds in repayments, but this comes at the expense of a longer-lasting debt and, therefore, more forked out on interest.

Hence, by stretching out repayments over longer periods, the SLC can magically reduce monthly repayments. Sadly, this means that -- overall -- graduates will pay far more interest under the new scheme than the present system.

In other words, tomorrow's graduates are about to learn the most unpleasant financial lesson of all: that repaying debt over long periods always produces whopping interest bills!

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