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It is said to have been Albert Einstein who called compound interest “the eighth wonder of the world”, and at this time of the year when some 400,000 fresh faced students are about to set off to university for the first time, they and their parents would be well advised to study what he meant.
Thanks to the application of compound interest to their student loans, this year’s new students will be faced with truly awesome debts, of a size which few of them have troubled to contemplate.
With maximum fees of £9250 per annum being applied by many universities, and a living allowance of £4193, on graduating after three years, including interest will already owe £45452. Those on four year courses (such an engineering and modern languages), and those studying in London will owe more.
If they are then lucky enough to get a job earning £31,000 per annum (more than the typical starting salary) repayments of £900 will be made in the first year, but interest of £2772 will have been charged and their debt will have grown by a further £1872. A real high flier with a salary of £41,000 will repay £1800 per annum (or £54,000 over the next thirty years) without having made any dent in their debt.
In fact you will have to be earning £51,800 per annum just to be covering the interest each year and stopping the debt getting even larger, and at that income, your total repayments (in other words what you will have paid to go to university) will be £83,160.
At the other end of the scale, those whose income never exceeds the repayment threshold of £21,000 per annum will accumulate debts of £279,455 over the thirty year course of the loan, and quite who will then be responsible for this debt is unclear, although one way or another it will eventually fall on the taxpayer.
Of course those who after graduating engage in further study, perhaps a masters degree and then a PhD may emerge from education with much larger debts, typically around £100,000. Suppose someone then pursues a career in academic science, where starting salaries for junior researchers are often quite low, even for those with higher degrees; if their salary remained under the £21,000 repayment threshold for ten years, they would owe £279,000. If they then obtained a really high flying job, the repayments might be large, but so would the interest accumulating each year.
Take an imaginary example of someone in that situation being appointed Vice Chancellor of Reading University on a salary of £261,000 per annum. They would repay £21,000 per annum, but the interest charges would be £17,000, so that their debt would diminish by a mere £4,000. It would be touch and go as to whether even at that salary they would ever repay their full debt, even though they would have repaid some £420,000 .
All of this assumes, that inflation (to which the interest rates are linked) remains at 3.1%. Some of us are old enough to remember interest rates of 10%, but thanks to the impact of compound interest, even a modest rise in inflation will make all of the above figures even more frightening.
In the meantime, I can only suggest to prospective students and their parents that they start refreshing their memory as to how Einstein’s eighth wonder of world is calculated.
Dr Barry Monk
The author is a consultant dermatologist who went to university at a time when all fees and living costs were paid for you.