End to interest-free student loans as new 1.5% rate revealed

Anyone who first took out a loan to cover university fees or living expenses from 1998 will be charged 1.5% initially, the Student Loans Company, which administers the government-funded cash, revealed this morning.

They will pay £150 a year on that rate, assuming a constant £10,000 debt, though the rate could jump if the Bank of England base rate rises. This is in contrast to the 0% interest such borrowers currently pay.

Those still clearing a loan taken out pre-1998 will pay 4.4% interest, as opposed to the minus 0.4% rate they currently pay. This higher rate was announced in April.

Instead of being PAID £40 a year, they will be charged £440 a year on a constant £10,000 balance.

Around 3.3 million people in the UK who first took out a loan from 1998 have outstanding balances, while roughly 355,000 have pre-1998 loan debts still owing.

Why are rates rising?

Interest for each academic year on loans taken out from 1998 is the lower of the Retail Prices Index inflation measure in the previous March (4.4% in March 2010) or one percentage point above the highest base rate charged by the major banks, which is effectively the base rate.

As the base rate is currently 0.5%, this produces the 1.5% student loan rate.

Interest on loans taken out pre-1998 is solely based on the previous March's RPI figure.

Broken promise

The Government last year temporarily abandoned its pledge to set rates in line with inflation or the base rate for millions, but it has now restored that link.

This time last year, the Treasury invoked a law allowing no interest rate to be set on loans taken from 1998, rather than setting a minus 0.4% rate, which was the previous March's RPI figure.

But those with pre-1998 loans are paying the March 2009 RPI rate of minus 0.4% for the current academic year (which ends in a few days).

Alana Fitzpatrick, MoneySavingExpert.com money analyst, says: "Students and graduates with a student loan can breathe a huge sigh of relief, following last year's broken promise, that the rate paid will once again be linked either to inflation or interest rates, whichever is lower.

"A student loan, in the long run, is the cheapest form of debt there is as the value of debt will never rise by more than the cost of living.

"So if you have an outstanding student loan balance, concentrate on paying other debts first."

Further reading/Key links

Student loans tool: www.studentloanscalculator.co.uk Student Loans MoneySaving guide: Student Loans 2009/10 Student loan help: Should I Pay Off My Student Loan? Student finance guide: Student MoneySaving