University costs: Should I borrow at 1% or let my son do it at 7%?

This article was originally published in This is Money.  

STUDENTS up and down the country will be heading for fresher events this week, eagerly embracing what will be one of the best times of their life. And so they should, following the awful curtailment of university life during the Covid years. 

For those parents who have built a little wealth, there is a weighty financial consideration to ponder. It is a roulette-wheel decision like no other I can think of in financial services: do you pay living costs for your child? Should you even offer to pay the fees? It’s something I’m wondering with my son heading to university this week. 

For some, tough love is the instinct: pay your way and stand on your own two feet! 

Others may feel inclined to do more, particularly those grateful to have been in a lucky generation when fees were paid and grants were common.  

I expect those who view family finances holistically, and as something to ruthlessly optimise, will fall into the latter camp and will have already been running the numbers, as I have. 

I’ve been looking hard and concluded that student loan decision-making throws usual financial rules on their head. Most obviously, rule no.1 - always borrow at the cheapest rates - may not apply. 

To make a wise and informed decision requires the skills of an actuary, a political analyst and a clairvoyant. Why? Because the safety nets in place for student loans result in wildly different outcomes for each borrower. And because politics could dramatically alter what happens to the whole system. 

Most of us will know now how the system works. University fees are capped at £9,250 a year in England. Students borrow from the government’s Student Loans Company for this - at a variable rate starting at 7.3% this year - and you don’t need to start repaying until you earn £25,000 (recently trimmed from £27,660). You repay 9% of everything earned above that mark, so a £35,000 salary results in repayments of £900 a year (9% of £10,000). 

Fans of the system call it a sensible graduate tax that makes higher education more accessible; opponents call it a debt timebomb. The rights and wrongs are for others to debate. My immediate concern is assessing the practical options open to you today.  

For example, it could be that you have enough money saved or invested that you would consider using some of your nest egg to pay the fees. Finance logic dictates that if you are earning, say, 4% on savings, it would be better to use some of that rather than borrow at 7.3%. 

Secondly, you may have access to cheaper debt elsewhere. Despite the gruesome headlines about mortgage rates, many people are still paying remarkably low interest rates. The rate on my five-year fix, for example, is 0.93% for another 3.5 years. Would it be prudent to fund my son’s education rather than overpay on such dirt-cheap debt? 

Put bluntly, pay 7.3% or pay 0.93%? 

I am, of course, being far too simplistic. It is probably unwise to side-line your long-term savings plans to help a child. If that paternalistic instinct is too strong perhaps the money is better set aside so it can be accessible at a time of great need. The biggest challenge facing 20 and 30-somethings is establishing a toehold on the property ladder. Assuming a rate of return of 5% after costs, £9,000 invested today (equivalent to one year of course fees) would grow to £14,823 by 2032, perhaps helping your child to buy a modest flat before they turn 30. Repeat the same action in the second and third year and you could have £41,000 accrued. 

Another good reason to take the graduate loans is the safety of the crowd. While there appears to be political commitment to the system today, who knows what might happen in the future. President Joe Biden has wiped out $39bn of debt for 804,000 graduates, directing help to those who still owed money after 20 years. 

If it can happen in the home of right-leaning economics then why not here? I’d rather side with the greater electoral power of those with student debt. 

And finally, who knows what might happen to your child. While you may envisage a lucrative career path today, who is to say what might happen in the next 40 years? They may choose a route you’d rather they didn’t.  

I specified 40 years with good reason, for that is the new horizon for when debts are wiped out. For previous students, the hallowed wipeout day came in as little as 25 years. In that vein, the caveat to all of this is that the rules keep changing - wipeout days move further away and repayment thresholds slide lower and lower. While I believe it’s right that my son takes all the loans today, I’d say it’s a close decision and it may not hold true in future years.  

I am grateful that I was able to leave university with very modest debts. I was the first intake to take a living costs loan back in 1991 - a mere £830 in London and with a rate of 2.3% which dropped to 1.5% in the second year if memory serves me correctly. The stakes were low for our lucky generation; today, with student debt exceeding £200bn, the stakes are much higher.

Student debt passes £200 billion at the end of 2022-23

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