The other student loan affordability problem

It's not just graduates that are struggling to afford student loan repayments. The IFS notes that covering the cost of loans is getting very expensive for the government. David Kernohan has a read

David Kernohan is Deputy Editor of Wonkhe

The government is losing money on the current English higher education fee loan model, and it does not account for this loss.

It’s one of those technical national account issues (expertly illustrated by IFS) that neatly illustrate the gap between the way the student finance system is perceived and the way it actually works. And it could have fairly serious repercussions for university funding and student repayments.

If you are hoping against experience for an increase in fee levels (or equivalent sums via the OfS allocation system) this is a very solid reason not to spend too much time hoping.

Gilt-y as charged

The issue relates to the cost to the government of borrowing money. UK government borrowing works via the issuing of “gilts” (basically government bonds, so-called because the old paper certificates used to have a shiny edge).

An investor buys a gilt – let’s say for £1 – and that pound is repaid by the government at the end of the specified term of the gilt (on average, around 15 years). But in the meantime, the owner of the gilt receives what is known as a “coupon” – a specified rate of annual interest. If the coupon was 5 per cent, you’d get 5p every year for 15 years followed by the return of your pound after 15 years – a total of £1.75 in cash terms.

In practice gilts are bought and sold all the time, so this interest rate income would be paid to a variety of owners over those 15 years. In working out how much to sell a gilt for an investor would consider the value of the gilt (here, £1 on a specified date) plus the value of remaining coupon payments, but would also account for the changes in the real terms value of this sum brought about by changes to the interest rate set by the Bank of England. The total – the basis of the price of a gilt – is called the “yield” of a gilt.

A grand don’t come for free

Imagine you’d won one of those “£1,000 a month for life” competitions you used to see back in the early 90s. Back then you’d have been delighted – you could certainly cover most of your basic living expenses with that cheque every month. But by the time we get to the back end of last year, that £1,000 would need to be more than £2,000 to pay for the same stuff.

It’s the same with gilts. A 5 per cent annual payment of interest was pretty impressive when the average annual interest rate was bumping along around 2 per cent. But last year the interest rate was around 8 per cent. Bad news if you are trying to sell a gilt – and even worse news if you are the government trying to sell lots of gilts. In the latter case, the response is to crank up the value of the coupon on gilts to encourage people to buy them, making government borrowing more expensive.

But it is when we turn to student loans that this problem becomes acute. The government borrows from the gilt markets (paying around 4 per cent interest), to lend to students who in turn pay interest at RPI – which currently means the government pays 1.6 per cent more in interest than it receives from graduates.

The upshot of this – as calculated by Kate Ogden, Nick Ridpath, and Ben Waltmann – is that the whole scheme is losing money. The financing costs in a single year give the government loss of £7.3bn.

The upshot

Though you’d never see it on a balance sheet or a RAB calculation, this circumstance means that the government is putting a lot of extra money into the student loan system right now. The issue is curiously amplified by the decision to stick with the outmoded RPI inflation measure (seemingly through to 2030, when it will be abolished in favour of CPIH) when it comes to calculating loan repayments – and by the recent (Plan 5) decision to ditch above RPI interest rates for repayment, a decision that disproportionately benefited well-off graduates, while the parallel increase of the repayment term to 40 years disproportionately affected less well paid graduates.

IFS notes that the “intuitive appeal” of graduates paying back no more than they borrow is a popular one, and that any increase in student loan interest rates is unlikely for political reasons. And the niceties of the national accounts mean that a higher interest rate actually makes the cost of supplying loans to students look (initially) higher.

It’s one clear reason why fee increases – or other additional funding for the sector – are very unlikely to happen.

4 responses to “The other student loan affordability problem

  1. An interesting bit of small print in the report about the practical impact of the issue the IFS identify is that they now estimate that the cost of the student loan system is only slightly higher than the government does (previously IFS had concluded that reforms – mainly the decision to freeze student loan repayment thresholds for several years and then only increase them with prices rather than with earnings – meant that there was no longer any subsidy to higher education):

    “However, it is worth noting that modelling the cost of student loans generally relies on strong
    assumptions, and DfE’s own model has long been more pessimistic about graduate earnings and
    thus student loan repayments than our model. As a consequence, even if we apply a discount rate
    reflecting the current 15-year gilt yield, our estimate for the long-run cost of student loans for the
    2023 entry cohort is only slightly higher than costs implied by official forecasts”

  2. If you want to circumvent this issue, then you can just make the interest on the student loan the same as the interest that the government pays on its loans (the Netherlands does this).

  3. Why does the Government pay anyone for borrowing money?

    The whole model seems to result in financial institutions making a profit from the Goverment that is paid for by taxpayers.

    1. Because THAT is Capitalism. If it didn’t, the Government would always have an advantage in providing any Good/Service, would be tempted to get involved in all sorts of things it probably shouldn’t (depending on your political persuasion), and crowd out all other risk-taking / entrepreneurialism / economic activity.

Leave a Reply