Inflation drives English student loan interest rate upwards

Graduates facing interest rate ‘rollercoaster ride’ in coming years unless changes are made to the way cap is implemented, Institute for Fiscal Studies says

April 13, 2022

Interest rates on student loans for English and Welsh graduates are set to rise to 12 per cent this autumn due to rocketing inflation, increasing debts by thousands of pounds.

The Institute for Fiscal Studies (IFS) has warned that the 13 April announcement that retail price index (RPI) inflation had risen to 9 per cent by March – the highest rate since 1991 – will have big repercussions on those who took out loans after the fee changes in 2012.

Graduates from this intake who earn more than £49,130 are currently facing interest rates of 4.5 per cent, which will more than double by September as the rate of interest for the highest earners is calculated by adding 3 per cent to RPI. Without policy changes, over six months this could add £3,000 to a £50,000 debt.

Lower earners – whose loans are currently accruing interest at 1.5 per cent – will face a new rate of 9 per cent while those who were given loans under the pre-2012 system remain unaffected because their interest rate is tied to the Bank of England base rate – currently 0.5 per cent – instead of RPI.

A cap that restricts student loan interest from rising above the average interest rate on unsecured commercial loans – known as the “prevailing market rate”, which was 6 per cent in February – should bring down the rate from 12 per cent to about 7 per cent by March 2023, the IFS predicted.

But it warned that the length of time it takes to implement this cap will result in “wild swings” over the coming years, with rates fluctuating from 0 per cent to 9 per cent until March 2025.

Ben Waltmann, a senior research economist at the IFS, said there was “no good economic reason” for the “rollercoaster ride” that graduates are facing.

“Interest rates on student loans should be low and stable, reflecting the government’s own cost of borrowing,” he said. “The government urgently needs to adjust the way the interest rate cap operates to avoid a significant spike in September.”

The IFS said while it would be impossible to apply an interest rate cap without any delay, the government should look at alternative policies as soon as possible. One suggestion involves capping student loan interest rates at the prevailing market rate from four months before student loan interest is charged, which would probably result in less fluctuation.

Ministers have just three months to come up with an alternative system or risk putting off prospective students from going to university due to the sky-high interest rates, the thinktank cautioned. Under the new fees system announced after the Augar review, all graduates who start courses from September 2023 will only accrue interest at the rate of RPI.

Hillary Gyebi-Ababio, the National Union of Students’ vice-president for higher education, said that the inflation figures were “brutal”.

“Increasing the maximum interest rate on student loans to 12 per cent will deter thousands of students from going to university, and will cause unparalleled uncertainty for the millions of graduates already repaying their loans with thousands of pounds added to their debt sheet,” she said.

“The government must immediately commit to reversing these planned changes.”

A Department for Education spokeswoman said: “Unlike commercial loans, student loans are protected in a number of ways. Monthly repayments for student loans are linked to income not to interest rates, or the amounts borrowed, and borrowers earning below the relevant repayment threshold make no repayments at all. 

“The IFS report makes it clear that changes in interest rates have a limited long-term impact on repayments, and the Office for Budget Responsibility predicts that RPI will be below 3 per cent in 2024. 

“Regardless, the government has cut interest rates for new borrowers so from 2023-24, graduates will never have to pay back more than they borrowed in real terms.”

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