Capping interest on student loans won’t help most graduates
Graduates across the UK will have rejoiced this week, after the government announced the miraculous on Tuesday: it was altering the terms of student loans to ease the pressure. In light of the situation in Iran and its potential to drive a steep rise in inflation, interest on (some) student debt will be capped at 6 per cent from 1 September.
According to the government press release: “This measure will protect students and graduates in England and Wales from the potential of inflation pressures due to the situation in the Middle East. Graduates will not pay the price for a war which the UK has no direct involvement in.”
It’s a shift in rhetoric from the government’s previous attitude towards young people who had the audacity to take out loans to fund their futures, with Rachel Reeves insisting in January that the current system – which has come under fire as the impact of the terms has become steadily apparent – is “fair and reasonable”.
So, if you took out a Plan 2 loan (beginning university between 2012 and 2023 in England and Wales), what will the changes mean for you? How will this magnanimous concession from the government affect your finances? How thankful should you be?
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The answer, alas, is not at all. The reality is the move announced this week will have no impact whatsoever on the vast majority of Plan 2 graduates it is purported to help.
Here is where we once more get into the weeds of how the Plan 2 system works, and why those subjected to it are so indignant. As well as tripling tuition fees to over £9,000 a year, the coalition government changed the interest and repayment terms, meaning students who embarked upon their degrees after 2012 face a radically different prospect to their immediate predecessors.
Interest on these loans is set according to the RPI rate of inflation (the highest of the various inflation indices) plus up to three percentage points depending on how much that graduate earns. This means that, however low interest rates in other parts of the financial world might be (during the Covid pandemic, the Bank of England base rate was 0.1 per cent and mortgages hit rock bottom), student debt will continue to grow far faster than wages or the economy in general. The result is that graduates can make thousands of pounds worth of payments over a decade and see their balances still higher than when they left university. It is estimated that a salary of £66,000 is needed for repayments on the average loan to start reducing the amount itself, rather than simply the interest.
This was the case before Donald Trump decided to intervene in Iran. And it will remain the case after the cap on the interest the government has just announced. (Caps, it is worth noting, have been applied before – indeed, one was in place when Labour took office in July 2024, ensuring the interest rate would not rise above 8 per cent.) The current interest rate is up to 6.2 per cent for those earning £52,884 or more (higher earners incur a higher rate of interest). Capping the interest rate at 6 per cent still means loans will be growing faster than most graduates can pay them down.
The bright spot for graduates is that unlike other forms of debt, student loans are written off 30 years after graduation. (The less bright spot is that this form of “debt” – which actually functions more like a graduate tax in many ways – can’t be avoided by declaring bankruptcy.) The exorbitant interest rate (which many graduates were not properly informed about when encouraged as teenagers to sign up for loans that even politicians did not seem to understand) means that around two–thirds of people who took out such loans are unlikely to ever repay them in full.
To be clear: they might repay what they originally borrowed, even accounting for real-terms inflation, but not the full balance once three decades of interest is applied. Only the highest-paid graduates can expect that heady feeling of seeing their loan balance fall to zero. The government is therefore expecting to wipe out large amounts of student debt. (No wonder the system for post-2023 students have been tweaked to increase the repayment term to 40 years.)
Again, all this was the case before the Iran war. Capping the interest rate at 6 per cent just means that, for the two-thirds of graduates who were never going to repay their loans in full, the amount of debt written off after 30 years will be lower than it would otherwise have been. The graduates themselves won’t see any extra cash. They will still be making monthly repayments until their early 50s, and the value of those repayments won’t change.
What about the lucky third of high-earning graduates who are on track to repay in full? Their loans will be lower than they would otherwise have been if the interest rate tracked Iran-fuelled inflation, but the impact is minimal. Calculating this depends on how high inflation might rise. According to Kate Ogden, senior research economist at the Institute for Fiscal Studies (IFS): “If March RPI comes in at 4 per cent, then this one-year interest rate cap might reduce expected lifetime repayments from a high earner with a typical Plan 2 loan by something in the region of £500 in today’s prices.” Obviously if inflation is higher, the amount saved will be greater – but it’s worth remembering that higher interest would also take more of the pay-in-full graduates into the debt-cancelled-after-30-years bracket.
And even for these graduates, their monthly repayments will not change. The interest rate is an important factor in understanding how onerous the Plan 2 system is, but it isn’t the only one. The repayment rate (9 per cent) and threshold (on earnings over £29,385) are what determine monthly repayments. The threshold was meant to rise in line with average earnings, but has been frozen for three years by Rachel Reeves in what is essentially a stealth tax specifically on aspirational young people, from whom the Treasury estimates it can raise an extra £400m a year. Graduates barely earning the London living wage and already struggling with the cost of living and a dysfunctional housing market face what is in effect a marginal tax rate of 37 per cent; for “higher” earners with incomes above £50,000, the rate is 51 per cent.
This is where the most pressing scandal of the student loans system lies. And while the interest rate is distortive and (some would argue) unjustifiable, when it comes to day-to-day finances it is the repayments that count. To repeat: these repayments will be affected not one jot from the interest rate cap. The amount of money young people who took out loans to invest in their futures have to pay their bills or save for a deposit will not change.
I asked the IFS how much this move was likely to cost the Treasury, considering what it mostly does is reduce debt it would have cancelled out anyway. This was, Ogden told me, very difficult to predict “not least because we don’t yet know what March’s RPI figure will be, and so what interest rates would have been in the absence of the new cap”. We might have a better idea in a few weeks’ time, “but how much this will cost government in the long-run (in lower future loan repayments) will depend on how graduates’ earnings evolve over the next 30 years”. The headline, however, remains clear: “It is likely a majority of Plan 2 borrowers will not repay any less over their lifetimes as a result of this cap.”
Ministers will not doubt still spin this as a major intervention to help struggling graduates. Perhaps they are trying to buy themselves some time to figure out the messy fundamentals of the system they inherited as it continues to come under fire; perhaps they are hoping people won’t notice how little this actually helps. But for all the government is patting itself on the back for “delivering stability and protections for graduates”, the truth is no graduate will benefit in the short term from this change – and most will not benefit at all.
[Further reading: Labour is divided over the Green threat]
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