Good news for those with student loans

At last, some good news on debt this month. Specifically, some great news for anyone with a student loan taken out after 1998. Thanks to a little-known clause in the small print of the loan agreement the interest rate has dropped twice since the start of December and is likely to keep falling. Here’s why.

The annual interest rate on student loans, set each September, is based on the rate of inflation as measured by the Retail Price Index (RPI) for the previous March. For example, last September the interest rate was set at 3.8%, as that was the RPI in March 2008. However, student loans taken out since September 1998 are classed as low interest loans under the Consumer Credit Act 1974. And as a consequence of one particular clause the interest rate on the loan must not be more than 1% higher than the average of the base rates from 11 major British banks.

As’s Simon Lambert points out, the huge base rate cuts made by the Bank of England in recent months mean that, for the first time, the student loan interest rate has breached this clause. As a result, the interest rate has been dropped. On 5 December last year it hit 3% and then, after another base rate cut last week, 2.5%. And there is a good chance of more cuts in the coming months. So what should you do?

While none of these reductions will affect your minimum monthly repayments – these are based on earnings – you will owe less in real terms next year as the total loan balance outstanding is now growing at below the rate of inflation. So for now don’t pay more than the minimum. Government-backed student loans are much cheaper than bank loans and you may need to borrow cheaply again in the future. There is no point paying this loan off quickly just to end up with a much more expensive commercial loan later.