Student loan interest rates are set to soar this year.
The Institute for Fiscal Studies warned that graduates paying off their student loans, mainly students who took out a loan after 2012, are in for a "rollercoaster ride". The maximum interest rate is set to rise to a staggering 12% for half a year for the highest earners, reported Manchester Evening News.
The IFS said that based on the current Retail Price Index (RPI) inflation rates, the changes will see the maximum interest rate on loans rise from 4.5% to an “eye-watering” 12% for half a year for the highest earners. Meanwhile, interest rates for low earners will rise from 1.5% to 9%.
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This means that a high-earning recent graduate with a typical loan balance of £50,000 would incur £3,000 in interest over six months, a higher amount than a graduate earning three times the median salary for recent graduates would usually pay. However, the spike in interest rates is only temporary, the IFS said.
The maximum student loan rate is set to fall to around 7% in March 2023, fluctuating between 7% and 9% for a year and a half, before then falling to around 0% by September 24, and rising again to around 5% in March 2025.
The IFS explained: “These wild swings in interest rates will arise from the combination of high inflation and an interest rate cap that takes half a year to come into operation."
The IFS said that without the interest rate cap, maximum rates would be 12% during the 2022/23 academic year, rising to around 13% in 2023/24. This “interest rate rollercoaster” is expected to cause problems, according to the IFS, as the interest rate cap disadvantages students with falling debt balances. It could also put students off going to university, or push graduates to pay off loans when this would have no financial benefit for them.
The interest rate rises are linked to the RPI and a rise in the cost of living. For borrowers from the 2012 university entry cohort onwards, interest on student loans is normally linked to the RPI. The rate is usually charged somewhere between the RPI inflation rate and the RPI inflation rate plus 3%.
But there is a lag between the RPI inflation rate and student loan interest rates, which the IFS calculates means that current high inflation rates will mean high student loan interest rates for 2022/23.
The IFS said: “This high reading implies an eye-watering increase in student loan interest rates to between 9% and 12%. That is not only vastly more than average mortgage rates, but also more than many types of unsecured credit. Student loan borrowers might legitimately ask why the Government is charging them higher interest rates than private lenders are offering."
Student loan interest rates are not supposed to rise above market interest rates, but lags between when the market interest rate is measured and the DfE taking action mean that between September 2022 and February 2023, students will pay uncapped rates. The situation is likely to disadvantage higher-earning graduates. Borrowers whose debt is falling over time will be charged more than those whose debts are rising. The IFS said this would lead to “unfortunate redistribution” between graduates.
Ben Waltmann, senior research economist at the IFS, said: “Unless the Government changes the way student loan interest is determined, there will be wild swings in the interest rate over the next three years. The maximum rate will reach an eye-watering level of 12% between September 2022 and February 2023 and a low of around zero between September 2024 and March 2025."
He added: “There is no good economic reason for this. Interest rates on student loans should be low and stable, reflecting the Government’s own cost of borrowing. The Government urgently needs to adjust the way the interest rate cap operates to avoid a significant spike in September.”
University and College Union general secretary Jo Grady said: “It simply cannot be right to saddle students with tens of thousands of pounds worth of debt and then subject them to the whims of volatile markets and rocketing interest rates. Today’s news will leave those already repaying their student loans preparing for increased debt payments during a cost-of-living crisis and force others to consider whether a university education is worth the cost at all. On any level, this is a policy disaster.”
A Department for Education spokesperson 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 spokesperson added: “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 predict that RPI will be below 3% 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.”
It comes after the government announced in February this year that students starting university courses in 2023/24 will have to begin paying back their loans once they are earning more than £25,000. The threshold for new students starting courses will be set at £25,000 until 2026-27, whereas the current salary threshold for repaying student loans is £27,295.
The student loan repayment period will also be extended to 40 years for students starting courses in September 2023.
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