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How the government’s loan repayments work

WARNING: If what follows sounds complicated, it’s because it is. The government has made its loans so complex that most students don’t really know what they are signing up for. According to this year’s Student Money Survey, run by www.savethestudent.org, 55 per cent of them admitted they don’t understand the repayment conditions. All the following details apply to government loans taken out after 2010/2011, when the system was changed. 

While students are studying their loans accrue interest set at the Retail Prices Index plus 3 per cent, starting the moment they take out the loan. After graduation the interest falls to RPI, until their income hits £21,000. It then increases to RPI plus 0.15 per cent for every £1,000 of additional income, up to a maximum of RPI plus 3 per cent for an income of £41,000 or more. 

Students don’t have to begin repaying their loans until they earn at least £21,000. At that point they pay 9 per cent of everything they earn over that sum – effectively, a graduate tax. But the interest on their loans keeps accumulating. Worse, the repayment rate is calculated on the borrower’s gross income, before income tax and national insurance, and paid out of net income. Anything not repaid after 30 years is written off. 

So, for example, a graduate starting work at a typical salary of £22,000 would repay £90 of their loan in their first year. But interest would be accumulating at the rate of RPI plus 0.15 per cent. With RPI at 3.3 per cent (the latest figure) and a typical total loan at the end of graduation for students starting this year of, say, £40,000, this ex-student would be accruing interest of £1,360 a year. So most graduates won’t be paying off any of the debt, just part of the interest. Overall, for a graduate starting work on £22,000, the debt would rise by £1,270 in year one. 

Graduates earning less than £21,000 – and even among those who find work straight away many earn less than that in the first couple of years – don’t have to repay anything. But their debt will increase by RPI each year. After 12 months their £40,000 debt will be £41,320.

You’d think higher-earning graduates – and there aren’t that many of them – would find it a lot easier to pay off their loans. Not so. The top interest rate of RPI plus 3 per cent is applied to the whole loan. As the Intergenerational Foundation points out, a law graduate starting at £42,000 a year but owing £40,000 would be repaying £1,890 of the debt. Yet interest will be accruing over the year to the tune of £2,640. Truly, another year older and deeper in debt.

Companion article: The next mis-selling scandal: why most of today’s students may never clear their debts.