(Some) student loan interest gets capped at six per cent

The change is framed as protection from external shocks:

…protect borrowers from future shocks due to war in the Middle East… government intervention will ensure borrowers don’t pay the price for a war which the UK did not start.

Skills minister Jacqui Smith said the move was to:

…provide immediate protection for borrowers, supporting those who are most exposed within this already unfair system.

Smith then reminded the public about the return of maintenance grants – which are of no use to graduates and won’t be in place until 2028 – before adding that the government is:

…continuing to look at the broken Plan 2 system we inherited, and the wider student finance system, to make it fairer for students, graduates, and taxpayers.

Interest rates on Plan 2 and Plan 3 student loans are set by academic year. They’d normally be based on the Retail Prices Index (RPI) figure from the previous March – which for 2026 to 2027 means March 2026. For Plan 3, the standard rate would normally be RPI plus three percentage points. For Plan 2, rates normally vary between RPI and RPI plus three percentage points depending on circumstances. The change is being made now, ahead of the setting of rates for the 2026 to 2027 academic year.

Alongside that RPI-based formula, there’s already a cap. The rate applied can’t exceed a “prevailing market rate”, which is calculated using Bank of England data on unsecured personal lending rates – as a 12-month rolling average – and reviewed monthly. In practice, this means that if inflation rises sharply and the RPI-based formula would produce a higher rate, the applied rate is reduced to this market-based ceiling. At present, that cap isn’t binding, because the formula rate for 2025 to 2026 is around 6.2 per cent and the prevailing market rate is higher than that.

The prevailing market rate cap in practice

That mechanism has already been tested – in both directions. In July 2021, the prevailing market rate for unsecured personal loans fell below the formula rate, and the cap was applied to bring Plan 2 and Plan 3 rates down. That cap remained in place, with a brief interruption in early 2022 when the formula rate dipped back below the market rate, before binding again from September 2022 as inflation surged.

For 2022 to 2023, the March 2022 RPI figure would have pushed the maximum Plan 2 and Plan 3 rate to around 12 per cent from September 2022 under the normal formula. In practice, that never materialised. The government capped the rate at 6.3 per cent from 1 September 2022, rising in stages – to 6.5 per cent, then 6.9 per cent, then 7.3 per cent – as the prevailing market rate itself climbed through the year. At the time, the Department for Education (DfE) was explicit that the 12 per cent figure was simply the formula output, and that intervention was required to prevent it feeding through to borrowers.

The cap stayed in place through 2023 to 2024 too, where the applicable RPI of 13.5 per cent would have produced a maximum rate of 16.5 per cent. Instead, rates climbed gradually under the cap to reach eight per cent by the end of the academic year – the highest the cap has ever been set.

The episode illustrates the gap between the optics of the system and how it actually operates. The spike in RPI made the headline formula look extreme, but the prevailing market rate cap meant the rate applied in practice was much lower. Borrowers were never realistically going to face a sustained 12 per cent rate – let alone 16.5 per cent. The pressure point was instead the credibility of the RPI-based formula itself, which became difficult to justify once inflation rose sharply.

The practical implication is that the existing cap was already doing most of the work. The new six per cent ceiling largely reinforces that existing protection rather than transforming how the system operates.

The cap also doesn’t apply evenly. Plan 2 interest varies between RPI and RPI plus three percentage points depending on the borrower’s earnings – only those earning at or above the upper threshold (currently £52,885) face the maximum rate. If March RPI comes in at, say, four per cent, the six per cent cap would only bite for graduates earning above roughly £45,000. Lower earners would already face a rate below six per cent and get nothing from this change. The borrowers Smith describes as “most exposed” are, in practice, the highest earners.

The cap also doesn’t change what most borrowers repay month to month. Repayments are determined by earnings above the threshold, not by the interest rate, so the amount deducted from September will be broadly unchanged. As the Institute for Fiscal Studies has pointed out, around two thirds of Plan 2 borrowers won’t repay in full anyway – for them, a lower interest rate just reduces the amount eventually written off by the Treasury, not the amount the borrower repays. For the minority of higher earners who will repay in full, the IFS estimates this one-year cap might reduce total lifetime repayments by something in the region of £500 in today’s prices. That is the actual material effect of an announcement framed as shielding millions from the consequences of war.

Meanwhile maintenance support is notably not subject to the same kind of protection. Maximum maintenance loans and postgraduate loans that contribute towards living costs have been uprated by around 3.1 per cent this year, while RPI is currently running at 3.6 per cent and likely to be higher still when the March figure is confirmed – the Bank of England was already expecting CPI in March to come in nearly half a percentage point above its early February forecast. That implies a real-terms squeeze in the value of support available to students. While interest rates on debt are being capped in response to inflation risk, the cash support intended to meet day-to-day living costs isn’t keeping pace with the same measure of inflation.

More politics than protection?

It’s also worth noting what happened to the public finances the last time inflation spiked and the implications for Reeves’ coming spending decisions. Even with the interest rate cap in place, the government booked a very large gain in the long term value of the loan book. That means that the writing off that had previously been done to loans had been overdone – generating notional extra cash in-year. A one-year six per cent cap doesn’t prevent that mechanism. It just constrains it. The Chancellor will still get what amounts to a spending windfall – which was worth £9.4 billion in 2022–23.

The framing of the Treasury Committee inquiry into student loan repayments is about fairness. By presenting this change as protection against inflation driven by international events, the government is able to position itself as shielding borrowers from external shocks. But the mechanics of the system mean the material effect for most graduates is limited. Monthly repayments are unchanged, and while balances grow more slowly, many borrowers won’t repay in full in any case.

Graduates will not pay the price for a war which the UK has no direct involvement in.

The line does political work, linking a technical adjustment to a wider narrative about economic security and government intervention. But it also risks overstating the effect. The system already contains a cap that prevents the most extreme outcomes from the RPI formula feeding through, and this additional ceiling largely reinforces that existing protection rather than transforming how the system operates.

There’s been sustained pressure to revisit the structure of student loans more fundamentally. Set against that backdrop, a one-year cap on interest rates looks like more fiddling with the system’s unsustainable parameters. The Treasury Committee inquiry closes on 14 April. If the stated aim is to make the system fairer for students, graduates, and taxpayers, the more difficult questions about the design of Plan 2 – and the role of interest within it – remain unresolved.