According to the Institute for Fiscal Studies (IFS), English and Welsh graduates who took out a student loan since 2012 will see student loan interest rates vary wildly in the coming years.

Today’s reading for RPI inflation means that the maximum interest rate, which is charged to current students and graduates earning more than £49,130, will rise from its current level of 4.5% to an eye-watering 12% from September 2022. The interest rate for low earners will rise from 1.5% to 9%.

This means that with a typical loan balance of about £50,000, a high-earning recent graduate would incur about £3,000 in interest over six months. This is more than even someone earning three times the median salary for recent graduates would usually repay during that time.

The maximum student loan interest rate is then likely to fall to about 7% in March 2023 and fluctuate between 7 and 9% for a year and a half. In September 2024, it is then predicted to fall to almost 0% before rising again to around 5% in March 2025.

These wild swings in interest rates will arise from the combination of high inflation and an interest rate cap that takes half a year to come into operation. Without the cap, maximum interest rates would be 12% throughout the 2022/23 academic year and around 13% in 2023/24.

While interest rates affect all borrowers’ loan balances, they only affect actual repayments for high-earning graduates who will pay off their loans.

The IFS says this “interest rate rollercoaster” will cause problems for graduates. It says the way the interest rate cap currently operates disadvantages borrowers with falling debt balances for no good reason.

Sky-high interest rates could also put some prospective students off going to university, while some graduates might feel compelled to pay off their loans even when this has no benefit for them.

For borrowers from the 2012 university entry cohort onwards, interest on student loans is normally linked to the Retail Prices Index (RPI). Depending on a graduate’s earnings, the interest rate charged is between the rate of RPI inflation and the rate of RPI inflation plus 3%.

But there is a long lag between RPI inflation being measured and it being reflected in student loan interest rates. The relevant RPI inflation rate that determines student loan interest in any given academic year is RPI inflation over the year ending in March of the previous academic year. So, for example, student loan interest rates are currently between 1.5% and 4.5%, because RPI inflation between March 2020 and March 2021 was 1.5%.

Ben Waltmann, IFS senior research economist, said: “At 9%, today’s RPI inflation rate is much higher than last year’s reading of 1.5%. This reflects the big rise in the cost of living over the past year.

“This high reading implies an eye-watering increase in student loan interest rates to between 9% and 12%. That is not only vastly more than average mortgage rates, but also more than many types of unsecured credit. Student loan borrowers might legitimately ask why the government is charging them higher interest rates than private lenders are offering.”

However, there is a little-known legislative provision that was meant to avoid precisely this situation. If the government determines that interest rates for comparable unsecured commercial loans are lower than the maximum rate of interest on student loans, it can cap it at what it calls the ‘prevailing market rate’. The latest prevailing market rate for February 2022 is 6%.

Waltmann adds: “So why are student loan interest rates still set to rise to up to 12% in September? The reason is that there is a six-month lag between student loan interest rates exceeding the cap and the student loan interest rate actually being reduced.”

Tom Allingham, Save the Student’s head of editorial, said: “At a time when students and graduates alike are having to contend with huge increases in the cost of living, today’s RPI announcement is yet another blow.

“If implemented, a maximum interest rate of 12% would massively exceed the previous Plan 2 high of 6.6% and represent an almost threefold increase on the current top rate. For lower earners whose loans accrue interest at the rate of RPI only, the use of March’s figure would mean that, come September, their interest rate will be six times higher than it is now.

“It’s worth noting that, as graduates only ever repay a percentage of their earnings over a threshold, any change to the interest rate won’t affect the amount people repay each month. However, higher interest rates do mean larger overall debts, which in turn means the loan takes longer to repay for those who may otherwise have done so earlier.”