Student loan early repayment penalty plan scrapped

Ministers were considering levying annual charges of about 5% on overpayments in excess of the minimum required, under the new regime which begins in September.

But a government source confirmed to MSE today that no early penalties will be levied. We had campaigned against possible charges in our submission to a consultation on the matter (see Martin's student loans blog which outlines our response).

The plan was due to be announced by the Department for Business next week, but was leaked last night.

The lack of early repayment fees will allow those who run into cash after university to clear their debt earlier and avoid interest costs.

Student will face fees of up to £9,000 a year under the new scheme.

But as the debt is wiped after 30 years, and repayments are based on how much graduates earn, those on lower incomes will often be better off not repaying early as they may never have to pay all their debt back anyway.

Martin Lewis, MoneySavingExpert.com creator and head of the Independent Taskforce on Student Finance Information, says: "These plans were thought up as a sop to make loan repayments progressive. 

"Yet that totally missed the bigger picture. While student loans are a hybrid between a debt and a tax because we call it a loan, early redemption penalties to discourage people from repaying quickly would have been a nightmare for financial education. 

"Over the years we've regulated against companies levying these type of penalties, so for the Government to have added them would have been wrong – and we told them strongly in our consultation submission.

"However, the maths behind this isn't so simple. Even though people will now be able to repay without penalties, it doesn't mean they should. 

"Large numbers of  people who aren't on high salaries after university won't pay off their loans in full over the 30 years before the debt wipes. 

"In that case, making overpayments, especially if just slightly accelerating what you pay, could be throwing money down the drain as it won't make any difference."

Under the new system, a graduate who earns more than £21,000 a year (in today's money) will repay 9% of their earnings. Higher earners will also pay more interest.

See our Student Loans 2012 guide for more information on the new regime.