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Interest rates on student loans rising to up to 12% – what does this mean?

12 May 2022 | Posted by Claro Money

The Government has announced that student loans taken out since 2012 in England and Wales will be charged up to a 12% interest rate from September, a substantial increase from the current rate which can be as low as 1.5%.

At the moment, the interest rate on post-2012 student loans in England is calculated by adding up to 3% to the retail price index (RPI) measure of inflation. It’s an older measurement of inflations that’s used to calculate the cost of living and wage escalation. As inflation (RPI) is increasing, this calculation could see those with plan 2 loans paying up to 12% a year in interest.

For graduates, the interest rate on loans is linked to salary, so those falling in a bracket below £27,295 after graduation will be charged RPI, but won’t repay the loan until they earn over that amount each year. Depending on your repayment plan, the amount you repay and when you need to start repaying it can vary. Let’s take a look at what this means for you.

How do student loans work?

Student loans allow you to borrow money to pay for university and college, which you’ll need to pay back once you start earning. It can cover tuition fee loans, maintenance loans (for things like rent, bills and textbooks) and postgraduate loans, even if you end up leaving the course early. You don’t need to repay other student financing like grants and bursaries.

In the United Kingdom, student loans and grants are mainly provided by the government through the Student Loans Company (SLC). It’s a non-profit organisation that’s sponsored by the Department for Education and gives loans and grants to students in colleges and universities in the UK, enabling people to borrow money so they can invest in their future. 

Student loans are broken into three different plans:

Plan 1: Pre-2012 loan – English / Welsh undergraduate student

Plan 2: Post-2012 loan – English / Welsh undergraduate student

Plan 4: Post-1998 loan – Scottish undergraduate or postgraduate student

How will this new increase affect me?

While the interest you’re charged will be increasing, you’ll still be paying 9% on everything you earn over £27,295 (or £2,274 a month) if you got a Plan 1 or Plan 4 loan.

The new increase only affects Plan 2 loans, which will still pay 9% and then up to 3% more on top of that due to the increase in RPI. For a graduate in a high-earning bracket of over £49,130 per year, the Institute for Fiscal Studies projects that an average graduate with £50,000 debt will incur around £3,000 in interest over six months, but it’s likely a short-term measure.

For a graduate earning under £27,295, the six months of higher rates would mean around £2,300 in interest overall.

In essence, if you’re on a lower wage, you’ll pay very little (or nothing at all until you reach £27,295). There’s an element of fairness involved, whereby the higher your wages, the more you’ll pay.

How long will this change be in place?

The IFS forecasts that the maximum interest rate for a Plan 2 student loan will fall to around 7% in March 2023, hit 0% in September 2024 and go back to 5% in March 2025. This is because of a knock-on effect from high inflation and a scheduled interest rate cap that will come into effect in March next year. It’ll be a short-lived spike that lasts around six months. 

The cap is law-abiding, stemming from a rule that states student loan interest rates can’t exceed the cost of unsecured commercial loans from the high street.

Will the effects be felt long-term?

Even with the fluctuations in interest rates, the IFS reckons that the short spike on post-2012 loans should level out and not leave too much of a lasting difference in the amount that graduates end up repaying. 

The main concern is that the increase will discourage potential students from applying to go to university, as the interest rate can be a daunting factor when figuring out budgets.

If you’re thinking about taking a gap year this year (2022-2023), it may be wise to defer it. From September 2023, graduates will pay their loans back over 40 years before it’s written off, as opposed to 30 years as it stands. They will also start repaying the loans once they earn over £25,000, compared to the current amount of £27,000. 

The changes won’t be implemented retrospectively, so students that began their degree before 2023 won’t be subject to the new changes regarding their loans. 

FAQs about student loans

How much is a student loan?

In the UK, it’s based on your university or college’s individual tuition fee and will be paid directly to them. Currently, full-time students can get up to £9,250 each year. Students of an accelerated degree course can get up to £11,100.

How much are tuition fees?

In England, it’s £9,250 per year and will stay frozen at that amount until September 2025. In Wales, tuition fees are £9,000 currently.

Do I have to borrow the full amount of my tuition fees?

No, you can borrow as much as you need to. The cost of certain courses varies, so you can request the exact amount you need. Naturally, the less you borrow, the less you’ll have to repay over time.

How do I repay my loan?

Once you find a job after graduation, the Student Loans Company keeps track of how much you’re earning and will alert your employer when you’re eligible to start repaying the loan. The company you’re working for will then deduct the correct amount and pay it on your behalf. If you’re self-employed, the onus is on you to pay the right amount.

Can I pay off my loan ahead of time?

Absolutely. You can pay it all off in one go if you’re in a position to do so. Paying more towards your loan can help you avoid paying any more interest than is necessary. But it’s worth checking your specific plan type to see how long it is before your debt will be written off. In some cases, you may not even finish repaying before it’s wiped, so paying it off early may not be the wisest choice.

What if I decide to leave the UK?

You’ll need to inform the Student Loans Company who will determine whether you need to pay off the loan while you’re gone. The repayment amounts depend on which plan you’ve initially chosen and it can be paid online or by an international bank transfer.

Do student loans get written off in the UK?

Loans taken out before 2006/2007 will be written off when you turn 65. Loans from between September 2006 and September 2012 will be written off after 25 years. Loans since September 2012 will be written off 30 years after repayment begins. New rules are coming into effect in September 2023 which means it’ll be 40 years before they’re written off.

Will debt collectors come after me?

No. Student loans are paid like income tax, so they’re deducted by your employer. You don’t have a choice, it’ll be debited automatically.

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