Student loan interest and payments

Student loan interest and payments – a more informed decision

Welcome to this article, which aims to give you the lowdown on student finance. Our mission is to provide clarity and transparency about how student loan interest and payments work. Armed with this knowledge, you’ll be able to make a more informed decision before taking on student finance.

In April 2022, the government announced changes to student loans, increasing the repayment period from 30 years to 40 years, for all students attending university from September 2023 onwards. This cohort has loans under PLAN 5.

Students who started university in 2012 through to 2022, have PLAN 2 loans, repaying them over 30 years. Below is a brief comparison of the two plans.

Student loan interest & payments

Interest is charged on student loans, and loan repayments are 9% on earnings above the threshold. The current threshold for Plan 2 loans is £28,470 per year, from April 2025. This means you will only start repaying your loan once your earnings exceed £28,470 (£27,295 before April 2025) and you will pay 9% on your earnings above the threshold. Interest on student loans is charged based on the retail price index (RPI). The government may intervene and cap the interest rate to avoid excessively high rates, as in September 2022, when it capped the rate at 6.2% for Plan 2 loans.

Plan 2 threshold from April 2026

The threshold for PLAN 2 loans will increase to £29,385 from April 2026. After April 2026, the threshold will be frozen at £29,385 for 3 years until the 2029/2030 tax year.

Types of student loans

Student loans are available for university fees and maintenance loans to cover living costs. Annual university fees for undergraduate degrees have increased from £9,250 to £9,535 from 2025/26. The government has announced that university fees in England will increase annually in line with inflation from 2026. An important point to note is that maintenance loans are means-tested, based on your parents’ income. What does this mean? The higher your parents’ household income is, the less you will receive as a maintenance loan. Parents need to be aware of this and appreciate that if they are higher earners, there is an expectation by the government that they will contribute towards their children’s living costs whilst at university. Students from more modest-earning families receive higher maintenance loans than students from higher-earning families.

HMRC has a handy calculator that estimates how much student finance you are eligible for:

Student finance calculator – GOV.UK (www.gov.uk)

Repayment of loans

The common assumption under PLAN 2 loans is that most students will never pay back their full loan. This is a valid assumption for students who earn modest to average salaries during their working careers. High-earning graduates are more likely to repay their loans in full, plus accrued interest. Some parents may consider paying their child’s university fees to avoid incurring student debt. Where students are studying for a degree that will place them in a high-earning profession, this is certainly worth considering to avoid accruing loan interest.

Students with PLAN 5 loans, repaying their loans over forty years, are far more likely to repay their loans in full. The interest rate on plan 5 loans is lower than on plan 2 loans. Interest is incurred at RPI on plan 5 loans, which means the loan amount increases in line with inflation, so in effect, it is not so much an interest charge but an inflation-tracking adjustment.

PLAN 2 loans

Interest rates

PLAN 2 loans incur interest at varying rates. Whilst at university the interest rate charged on the loan is RPI (retail price index) plus 3%. Interest is charged from the date the loan is taken. Once you start working the interest rate is variable. If your earn less than the threshold of £28,470 interest is charged at RPI. If you earn between the threshold and £51,245, interest is charged on a sliding scale between RPI plus 3% depending on your income level. Once your income exceeds £51,245 the interest rate is RPI plus 3%.

Loan repayments

Graduates on PLAN 2 loans, make repayments of 9% of their earnings above the current repayment threshold of £28,470. For example, if you are earning £30,000 a year, you will pay 9% on £1,530 (£30,000 -£28,470), which is £137.70 a year or £11.48 a month. You’ll pay 9% on earnings above the threshold for 30 years or until your loan is paid off, whichever comes first. The government should increase the threshold annually by the rate of inflation. If the threshold increases in line with salary inflation, repayments should remain at a similar percentage level of your total income.

PLAN 5 loans

Interest rates

PLAN 5 loans incur interest at RPI only, throughout the loan. Figures suggest that under Plan 5 loans, the percentage of graduates repaying their full loans will rise from 23% to 52%.

Loan repayments

Graduates on PLAN 5 will have repayments of 9% of their earnings over the threshold of £25,000. On a salary of £30,000, the loan repayment is 9% of £5,000 which is £450 a year or £37.50 a month. Repayments are made for 40 years or until the loan is paid off. The threshold of £25,000 is fixed until 2026/2027. When the threshold is fixed and you receive inflationary salary increases, your repayment increases in real terms as there is no corresponding inflationary adjustment to the threshold.

The financial details

Compounding interest

When you take student finance, interest is charged on a compounding basis from the date you receive the funds. You incur interest on your loan whilst at university. The first interest charge is based on the initial loan or capital amount. Subsequent interest is calculated on the initial loan amount (capital) plus accrued interest. The interest charge increases slightly every month as it is calculated on the capital balance plus the ever-increasing accrued interest. You are paying compounding interest, which is interest on interest. In year one, you incur interest on your first year loans, whilst in year 2, interest is incurred on both first-year and second-year loans. In year 3, interest is charged on three years of loans.

Loan repayments

Repayments of your student loan commence in April after you graduate and are 9% of your earnings over £28,470 for PLAN 2 loans and 9% of earnings over £25,000 for PLAN 5 loans. Initially, your loan payments will be allocated against the interest you incurred while at university. Your initial repayments are likely to be low as most graduates do not earn high salaries for the first few years after finishing university. It is unlikely that during your first few years of working, your repayments will reduce any of the capital (the original amount that you borrowed). Higher-earning graduates are likely to start repaying the capital element of their loans further along in their careers. Modest and lower earners with PLAN 2 loans will likely only ever repay some of the interest and eventually have their loans written off after 30 years. A far higher percentage of graduates with PLAN 5 loans will repay their loans and accrued interest in full.

Repayment thresholds

Ideally, the loan repayment thresholds should increase annually by inflation, or by the percentage of salary inflation. To illustrate the impact of inflation, assume you have a PLAN 5 loan and earn a salary of £30,000. Your loan repayments are £450 per year or 0.015% of your annual pay. With both a salary and threshold increase of 3%, the new salary is £30,900, and the repayment threshold increases to £25,750. The loan repayments are now £463.50, which is a 3% increase on the original £450 amount. In real terms, the loan repayments remain consistent at 0.015% of the increased salary of £30,900.

However, when the threshold is frozen, loan repayments increase in real terms. In the above example, if the loan repayment threshold remains at £25,000, the loan repayment jumps to £531 on the new salary of £30,900. This is an increase of 18% on the previous loan payment of £450, or 0.017% of the increased annual salary.

The government sets the loan thresholds, and as illustrated, freezing them impacts the repayments. When salaries rise with inflation but loan thresholds are frozen, more graduates’ earnings fall above the repayment threshold. When loan thresholds aren’t increased by inflation, the result is an increased financial burden on graduates in real terms.