Students forced deeper into debt as inflation surges to 4.4%

More than 3.5 million students and graduates face a hefty increase in their student loan rates later this year after an unexpected surge in inflation last month.

Interest rates on student loans are linked to the retail price index (RPI) each March. Official figures published yesterday showed that this measure of inflation jumped to an 18-month high of 4.4 per cent.

Those at university or college can take out student loans up to a maximum of £10,153 a year, depending on where they are studying, leaving some with debts of about £30,000 when they leave after three years.

Interest added from when loan taken

Although graduates do not have to start paying off the loan until they earn £15,000 or more a year, the interest starts rolling up on the loan from the day they take it out.

RPI inflation fell into negative territory for the first time in 50 years last year as the recession took its toll of the economy.

In March last year the rate of inflation measured by the retail price index stood at -0.4 per cent, handing millions of students an interest-free year on their student loan accounts.

Although last month’s rise in RPI inflation is expected to be temporary, it will leave students and graduates facing an uncomfortable increase in payments.

Interest rates to raise in September

Nearly 400,000 graduates are still paying off loans taken out before 1998 that track the RPI alone. From September they will see the interest rate on their loans rise from -0.4 per cent to 4.4 per cent.

The 3.3 million graduates and students who have taken out a loan since 1998 pay either the RPI inflation rate or the bank base rate plus 1 per cent, whichever is lower.

They are paying no interest this year, but are likely to face interest charges of between 1.5 and 1.75 per cent from September, when the exact rate on their loans will be announced.

The base rate is currently at a record low of 0.5 per cent. If it stays there until September, the new rate would be 1.5 per cent. However, if interest rates rise later this year or next year, as many economists forecast, student loan rates will increase too — and will stop rising only if they reach 4.4 per cent.

Many economists expect that the Bank of England will raise rates at least once before the end of the year.

Steven Jackson of BeatMyDebt.com is worried that students do not appreciate the debt they taking on. “Many students focus on the fact they wil not have to start repaying their debt until they are earning £15,000. However, with interest being added each month, the amounts originally borrowed can increase considerably” he said. “Debts incured while studying are often some of the hardest to repay and can not be written off with an individual voluntary arrangement or bankruptcy” he added.

A 1.75 per cent interest rate would add £525 to the bill for those graduating in the summer who have taken out the maximum student loan.

Cheap credit

Despite this, experts said that student loans were still some of the cheapest credit available.

Martin Lewis, of the consumer website MoneySavingExpert.com, said: “Until September, student loans are at least interest free. The last thing you should do if you have spare cash is to pay off the debt any more quickly than you planned to.

“While 4.4 per cent is not cheap, student loans are still the least expensive long-term debt you’ll ever get.”

The consumer price index (CPI), the Bank of England’s target measure of inflation, also surged last month, rising from 3 per cent to 3.4 per cent.

The jump in inflation was also bad news for savers who will see the value of their nest eggs eroded faster as the cost of living rises.

Experts said that in order to stop their savings pot effectively eroding away, a basic rate taxpayer would need to find a savings account paying 4.25 per cent, while a higher rate taxpayer would need to find an account paying 5.64 per cent.

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