In October, the Prime Minister called for an inquiry into the student loan system for higher education (HE). In this briefing note, we focus on two of the more unpopular features of the current system. We explore government options for reducing the interest rates charged on student loans, from the current levels of RPI + 3% while studying and RPI + 0–3% (depending on income) after leaving university, and for reintroducing living-cost grants – which do not have to be repaid – for students from lower-income families. This briefing note will be submitted as evidence for the inquiry.
- Positive real interest rates on student loans increase the debt levels of all graduates but only increase the lifetime repayments of higher-earning graduates. Removing them does not affect up-front government spending on HE, but it does slightly increase the deficit (due to the slightly confusing treatment of interest accrued on student debt in the government finances). More significantly, it also increases the long-run costs of HE due to the associated reduction in graduate repayments.
- Reducing the interest rates to RPI + 0% for everyone would reduce the debt levels of all graduates. Debt on graduation would be around £3,000 lower on average, while average debt at age 40 would be £13,000 lower. However, because of the link between income and interest in the current system, this cut would reduce the debts of the highest-earning graduates the most: the richest 20% of graduates would hold around £20,000 less debt at age 40 as a result of this policy, while the lowest-earning 20% of graduates would be just £5,500 better off in terms of debt held at the same age.
- This policy of switching to RPI + 0% would have no impact on up-front government spending on HE, but would cost the taxpayer £1.3 billion per year in the long run. It would be a significant giveaway to high-earning graduates, saving the richest 20% more than £23,000 over their lifetimes.
- A less costly policy would be to reduce interest rates to RPI + 0% while studying and leave rates unchanged after graduation. This would reduce the debt levels of all graduates at age 40 by around £5,000. It would be a significantly cheaper reform, costing around £250 million per year in the long run. Again, there is little impact on the repayments of low- and middle-earning graduates, while the highest-earning graduates would be around £5,000 better off over their lifetimes.
- Reintroducing maintenance grants in place of loans also has no impact on up-front government spending on HE, but it results in a large increase in the government cost of HE as measured by the current deficit, due to the differential treatment of loans and grants in government accounting. The long-run cost of this type of policy is typically much lower as a large proportion of the loans that grants would replace are not expected to be repaid anyway.
- Reintroducing grants of £3,500 under a similar system to that before 2016 would increase deficit spending by around £1.7 billion, but the long-run cost is only around £350 million. This reform would reduce the debt on graduation of students from low-income backgrounds taking a three-year degree by around £11,000.
- The beneficiaries from this change in terms of actual lifetime loan repayments are students from low-income backgrounds who go on to have high earnings. We estimate that students eligible for the full maintenance grant who are in the lowest-earning 60% of graduates would experience little or no change in lifetime repayments, while those who have earnings in the top 10% of graduates would save around £22,000.