The government is capping the maximum interest rates on Plan 2 and 3 student loans at 6% from 1 September, instead of RPI +3%, for the 2026/27 academic year. This will affect students and graduates in England and Wales and is against a backdrop of a Bank of England base rate at 3.75%.

However, it has not increased the repayment threshold so graduates still face a punitive financial environment.

The government was forced to take action as it was worried about the threat of rising inflation due to the war in the Middle East which would have had an even more immediate impact for student loan repayment rates.

‘This reform removes the risk of any temporary increase in inflation causing loan balances to compound at an unsustainable rate and is in line with actions taken in the past to secure stability in the student finance system,’ the Department for Education said.

Graduates with Plan 2 loans currently pay interest rates of between RPI and RPI plus 3%, depending on their earnings. This rate is usually significantly higher than the government’s preferred CPI measure when increasing other thresholds, although tax thresholds are frozen for the next five years, creating damaging erosion of take home pay for years to come.

Current students on Plan 2 and Plan 3 also have to pay an interest rate of RPI +3% while they are studying.

The average graduate debt for students on Plan 2 loans after leaving university rose to £53,000 in 2024-25, which was £5,000 higher than £47,000 just a year earlier.

Plan 2 graduates pay back student loans at a rate of 9% of their current earnings, on top of income tax, national insurance contributions (NICs), and other deductions such as auto enrolment work pensions. This can result in very high marginal tax rates for some high earning graduates.

The cap on interest rates comes after the government increased the repayment threshold for Plan 2 loans to £29,385 from 6 April.

Ian Futcher, financial planner at Quilter, said: ‘The interest rate cap does little to change the financial reality graduates are living with. The real pressure point is the frozen repayment threshold, which is pulling more people into repayments earlier, as wages rise but still struggle to keep up with rising costs.

‘Without movement on the repayment threshold, graduates will continue to feel the strain, not because of headline interest rates, but because student loan repayments sit alongside some of the toughest housing and cost of living conditions seen in a generation.’

However, there is no change for students on Plan 5 loans who will face a very low bar for starting to pay back their loans, perilously close to the national living wage based on full-time earnings.

Graduates who started their courses from 2023 onwards are on Plan 5 loans with repayments kicking in at earnings of £25,000 over a 40-year payment period.

Minister for skills, Jacqui Smith, said:  ‘We know that the conflict in the Middle East is causing anxiety at home, and while the risk of global shocks is beyond our control, protecting people here is not.

‘Capping the maximum interest rate on Plan 2 and Plan 3 student loans will provide immediate protection for borrowers, supporting those who are most exposed within this already unfair system.

‘More broadly, we’re bringing back maintenance grants and 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.’

The interest on student loans is fixed by academic year, from 1 September to 31 August the subsequent year, based on the RPI value for the year to March 2026.