The interest rate some graduates are paying on their student loans will hit 12% in September as high inflation triggers an interest rate roller coaster for those with student debt.
According to the Institute for Fiscal Studies (IFS), English and Welsh graduates who have taken out student loans since 2012 will see student loan interest rates vary wildly in coming years.
Today’s reading for RPI inflation means that the maximum interest rate, which is charged to current students and graduates earning over £49,130, will rise from its current level of 4.5% to 12% at from September 2022. The interest rate for low wages will increase from 1.5% to 9%.
This means that with a typical loan balance of around £50,000, a recent high-income graduate would incur around £3,000 in interest over six months. That’s more than even someone earning three times the median salary of recent graduates would typically repay during that time.
The maximum interest rate for student loans should then fall to around 7% in March 2023 and fluctuate between 7 and 9% for a year and a half. In September 2024, it is then expected to fall to nearly 0% before rising to around 5% in March 2025.
These wild swings in interest rates will stem from the combination of high inflation and an interest rate cap that takes six months to come into effect. Without the cap, maximum interest rates would be 12% throughout the 2022/23 academic year and around 13% in 2023/24.
Although interest rates affect the loan balances of all borrowers, they only affect the actual repayments of high-income graduates who will repay their loans.
The IFS says this “roller coaster of interest rates” will cause problems for graduates. He says the way the interest rate cap currently works disadvantages borrowers whose debt balances fall for no good reason.
Exorbitant interest rates could also deter some prospective students from going to college, while some graduates may feel pressured to repay their loans even though there is no benefit to them.
For borrowers starting with the 2012 college-entry cohort, student loan interest is normally tied to the retail price index (RPI). Depending on a graduate’s earnings, the interest rate charged is between the RPI inflation rate and the RPI inflation rate plus 3%.
But there is a long lag between measuring RPI inflation and factoring it into student loan interest rates. The relevant RPI inflation rate that determines student loan interest in a given academic year is the RPI inflation in the year ending March of the previous academic year. So, for example, student loan interest rates are currently between 1.5% and 4.5%, because RPI inflation between March 2020 and March 2021 was 1.5%.
Ben Waltmann, senior research economist at IFS, said: “At 9%, today’s RPI inflation rate is much higher than last year’s 1.5%. This reflects the sharp increase in the cost of living over the past year.
“This high value implies a meteoric increase in interest rates on student loans between 9% and 12%. This is not only significantly more than average mortgage rates, but also more than many types of unsecured credit. Student borrowers might legitimately ask why the government charges them higher interest rates than those offered by private lenders.
However, there is a little-known legislative provision that was specifically intended to avoid this situation. If the government determines that the interest rates for comparable unsecured commercial loans are lower than the maximum student loan interest rate, it can cap it at what it calls the “prevailing market rate.” The latest effective market rate for February 2022 is 6%.
Waltmann adds, “So why should interest rates on student loans rise again to 12% in September? This is because there is a six-month lag between student loan interest rates that exceed the cap and the student loan interest rate that is actually reduced.
Tom Allingham, Managing Editor of Save the Student, said: “At a time when students and graduates are facing huge increases in the cost of living, today’s RPI announcement is a another blow.
“If implemented, a maximum interest rate of 12% would massively exceed Plan 2’s previous peak of 6.6% and represent an increase of nearly three times from the current maximum rate. For low-income people whose loans bear interest at the RPI rate only, using the March figure would mean that by next September their interest rate will be six times higher than it is now.
“It should be noted that because graduates only repay a percentage of their earnings above a certain threshold, any change in the interest rate will not affect how much people repay each month. However, higher interest rates mean larger overall debts, which means the loan takes longer to repay for those who might otherwise have done so sooner.