Student loans are critical for many people pursuing higher education. However, the intricacies of interest rates can make these loans difficult to understand. A student loan is a binding legal contract, so it’s important to understand clearly what you’re signing up for, including how much you’re borrowing, how much you’re expected to pay back, and what the terms of your loan agreement are. Understanding the interest rate of your loan is particularly crucial for effective financial planning and managing your money both during your time as a student and when you enter the working world.
Here, we explore the types of student loans, their interest rates, how they’re calculated and what your repayment arrangement will typically look like.
Which plan are you on?
For all student loans in the UK, there is a repayment threshold. This means you won’t begin to repay your loan or any interest until you earn over a set amount from your employment. This varies depending on your plan type:
| Plan type | Yearly threshold | Monthly threshold | Weekly threshold |
| 1 | £24,990 | £2,082 | £480 |
| 2 | £27,295 | £2,274 | £524 |
| 4 | £31,395 | £2,616 | £603 |
| 5 | £25,000 | £2,083 | £480 |
| Postgraduate | £21,000 | £1,750 | £403 |
Interest rates for the various student loan plans differ depending on many factors, including when you started your course, the course type, and your income. You can check which plan you’re on by logging in to your student finance account online.
Currently, the interest rates are as follows:
| Plan 1 | 6.25% |
| Plan 2 | 7.9% |
| Plan 4 | 6.25% |
| Plan 5 | 7.9% |
| Postgraduate Loan | 7.9% |
How interest is calculated
A fixed interest rate remains the same across the life of a loan. However, in the UK, student loan interest rates are linked to the Retail Price Index (RPI). The rate is updated annually each September, based on the RPI from March of that year. For example, if the RPI is 2%, the base interest rate for student loans will be set at 2% for the following year.
Therefore, a student loan in the UK technically has a variable interest rate, despite being predictable and set for a year at a time. This essentially offers a hybrid system between fixed and variable interest rates.
Students are currently charged RPI plus up to 3%, depending on personal circumstances and income. While studying, you’ll be charged RPI plus 3%, but once you’ve left your course, the amount of interest charged will depend on your income. If it’s less than £21,000 a year, you’ll only be charged RPI, but if it’s between £21,000 and £41,000, interest is charged on a sliding scale of RPI plus up to 3%. For those earning over £41,000, it’s RPI plus 3%.
Impact of interest rates on repayments
While interest is added from the day the loan is paid into your account until the day it’s cleared, the accumulated interest doesn’t affect monthly repayments (once they begin). This is because student loan repayments in the UK are based on an individual’s income. However, the total amount repayable includes the principal amount and the accumulated interest.
As with all loans, higher interest rates can increase the total balance and mean the loan takes a longer time to pay off. Although, it’s important to know that if your student loan isn’t paid off within 30 years, the balance is automatically cleared – with no negative effects on your credit score.
Managing your student loan
If you’re in a position to do so, making additional payments towards your student loan can help to reduce the amount faster – reducing the amount of interest you accrue. Looking ahead to your expected salary changes can help you decide whether or not making additional payments is worth your while, in order to reduce the overall interest.
However, as student loans differ from commercial loans in that your repayments aren’t based on the amount of interest, it’s recommended that you pay off debts with higher interest rates first. As most students will fail to repay the full amount of their loan before it’s written off, paying off your student loan early should come only after securing an emergency fund and clearing all other debts.
Therefore, experts recommend that you put any surplus funds towards savings accounts instead, unless you are certain that you will repay all of your student loans before the term comes to an end.
Clear financial decisions
Understanding how the interest rate works for your student loan is crucial for smooth and stress-free financial planning. By knowing the structure of your student loan, how much you’re expected to repay, and when, you can clearly envision what your finances will look like and make better decisions about managing this debt.
More on the subject can be found in our article on graduate debt.
