What should be done about student debt in England?

This article was first published in Times Higher Education, and is reproduced here with kind permission.

The recent furore around student loans took many by surprise – not least the chancellor.

The actual changes in the loan terms Rachel Reeves made at the November Budget were far from unprecedented. The repayment and interest rate thresholds on Plan 2 loans will be frozen for three years from April 2027; the same thresholds have been frozen in five of the past 10 years. Changes announced in 2022 – which included a change to the default indexation from average earnings to RPI, as well as a one-year freeze – will have a much larger impact on graduates over the longer term but prompted far less outcry.

What is different this time? The several million graduates with Plan 2 loans now constitute a sizeable – and vocal – block of voters, and the first students with these loans are now in their early thirties and making sometimes-hefty repayments. This has raised the political stakes of changing the loan terms.

Income tax thresholds have been frozen since 2022 and are set to remain so until 2031, making "fiscal drag" – increasing tax receipts by pulling more people into higher tax brackets – more salient. This has made it harder for the government to raise revenues quietly by freezing other thresholds, such as those for student loan repayments. And a period of high inflation since 2022 has led to much higher nominal interest rates on these loans. An interest rate cap limited the maximum rate applied when RPI was at its peak at few years ago but meant that for two years all Plan 2 borrowers were subject to the maximum interest rate, rather than only higher earners.

Even now that interest rates have come down, the vast majority of those with average-sized loans and on typical graduate salaries will be seeing their outstanding loan balances grow year-on-year. Someone with an outstanding loan of £50,000 would need to earn around £63,000 (and repay £260 each month) to see their loan balance stay the same – and would need to earn more than this to see it start to come down.

That many borrowers would have ever-rising loan balances was entirely foreseeable. It follows from the fact that graduates' repayments depend on their earnings, not on their balance or the interest rate. This means that, by design, actual repayments of these loans should never be unaffordable.

Any outstanding debt is written off after 30 years, of course, but policymakers may have underestimated how much graduates would care about the balance on their statement from the Student Loans Company – even if, for many, it will bear little relation to how much they actually go on to repay.

A plethora of potential reforms to Plan 2 student loans have now been suggested. These target different features of the current loan system that some people dislike – and would have very different consequences.

The Conservative proposal to reduce interest rates to RPI, for instance, would benefit middle and (particularly) high earners, who are most likely to eventually repay their loans with above-inflation interest. It would mean more graduates seeing their balances fall rather than rise year-on-year but would only reduce actual repayments many years in the future.

Proposals focused on increasing the repayment threshold – either cancelling the planned freezes or going further to undo the impact of earlier policy changes – would reduce monthly repayments from all those making repayments in the short term. The lifetime gains would be much larger for lower-earning graduates – although the reverse is true for higher earners, who might repay for longer and save very little overall.

Reprofiling repayments such that more is paid back later in graduates' working lives, as some Labour backbenchers have suggested, could reduce short-term repayments from those trying to get on the housing ladder or struggling with childcare costs. But it is not clear that graduates would be appeased by reforms that asked them to make repayments for even longer.

Of course, new students since 2023 are subject to the 40-year repayment terms of the new Plan 5 loans. The lower interest rate (RPI) means no one will repay more than they borrowed in real terms, making these new loans a substantially better deal for high earners; the DfE estimates that the top-earning fifth with Plan 2 loans can expect to repay nearly 40 per cent more than they borrowed in real terms.

But Plan 5 loans provide less protection to low earners, who can expect to repay more each month (owing to the lower £25,000 earnings threshold) and to repay for longer. Hence, shifting Plan 2 repayment terms in the direction of Plan 5 would be a substantial redistribution from lower- to higher-earning graduates – something that is unlikely to appeal to the current government.

More radical combinations of changes could reduce repayments in both the short and long term from almost all graduates – but would inevitably be much more costly for taxpayers. The proposals from Rethink Repayment, a graduate campaign group, would roughly halve repayments. Given the "fair value" of Plan 2 loans – the amount government expects to actually be paid back – was £129 billion this time last year, the one-off cost of such a reform would be well into the tens of billions.

Spending billions on student loan reform or forgiveness is unlikely to be the government's priority. But one change that would cost very little to implement would be a redesign of student loan statements. These could explain the unusual terms of the loans and give graduates more sense of how much they might actually expect to repay, reducing the unhelpful over-focus on outstanding balances.

Some called for this back in 2019, and it received a sympathetic hearing from the Augar Review. Now may be a good time for government to look again at this proposal – although it is unlikely to quieten calls for substantive loan reforms from many quarters.