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Making sense of student loan interest rates

Whether you are currently a student or a graduate with 10 years in the workforce, it is key to understand your student loan and how much interest you are paying. However, with two different loan plans and different thresholds depending on your earnings, it can all get a bit confusing. So let’s take a look and try to make sense of the world of student loan interest rates.

Firstly, what interest you are charged depends on what type of loan you have: Plan 1 or Plan 2. Here’s how you know which is which:

Plan 1 – You are an English or Welsh student who started an undergraduate course anywhere in the UK before 1 September 2012, or you are a Scottish or Northern Irish student who started your course on or after 1 September 1998.

Plan 2 – You started your course after 1 September 2012 in England or Wales.

Student loan interest rates on Plan 1

If you are on Plan 1, then basically the interest you are charged is kept in line with inflation. The interest rate on your loan will be the Bank of England base rate (currently 0.75%) plus 1%, or just the rate of inflation, whichever is lowest.

It is key to understand that therefore there is no real cost of borrowing with this type of loan, because what you are repaying is the rate of inflation. For example, imagine you have borrowed enough for 50 baskets of shopping at the supermarket. The numbers on your student loan statement increase as interest is added. However, because the amount is only increasing in line with inflation, in reality you have still only borrowed enough for 50 baskets of shopping – even if it is 10 years down the line.

This comes into play if you are considering overpaying your student loan or paying off your loan early. It may not make financial sense to overpay a Plan 1 loan, because the amount you owe in real terms is not increasing. If you do have some extra money, then consider paying off debts that are charged at a higher rate of interest, such as credit cards, or finding a savings account that pays a decent rate of interest and which you can gain more from financially than paying off your student loan.

Student loan interest rates on Plan 2

Plan 2 student loans are slightly different. While studying, and until the April after you have graduated, the interest rate on your student loan will be the Retail Price Index (RPI) plus 3%. The RPI at the time of writing is 2.4%, so the interest rate will currently be 5.4%.

After the April following your graduation, your interest rate will range from just the RPI to the RPI plus 3%, depending on how much you earn.

  • If you earn £25,725 or less, your interest rate will be the RPI (currently 2.4%).
  • If you earn between £25,725 and £46,305 your interest rate will be the RPI plus up to 3%. The added percentage will rise in line with your earnings. For example, if you earn £36,015 (midway in this band), your interest rate will be RPI plus 1.5%, which would currently be 3.9%.
  • If you earn over £46,305 your interest rate will be the RPI plus 3% (5.4%).

For Plan 2, the interest rate is set on 1 September each year, based on the RPI of the previous March.

There are two key elements to note with Plan 2. The first is that the interest rate will fluctuate (much like with Plan 1), because it is based on the RPI. But as this is just in line with inflation, it’s not a cause for concern. The other element is that the rate increases based on how much you earn. So if you earn above £46,305, then you will have the higher rate of 3%.

Much like on Plan 1, though, if you find yourself with some extra money, it is probably the more financially savvy option to look to save in a high interest account or pay off debt that has a higher interest rate. Yes, a rate of 5.4% can seem daunting, but it’s still well below the interest rate you would be charged on any credit card debt. And it is key to remember that a large portion of the rate is the RPI, so in reality the cost of borrowing is only 3%. 

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