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In the UK, student loan interest rates, once studies are finished, are set as Retail Price Index (RPI) plus up to 3%. Every other variable rate of borrowing that I am aware of is tied to central bank interest rates, for example mortgages.

Why was this decision made?

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    PRI used to be lower than base rates. This page has a graph that goes back to 2006; economicshelp.org/blog/5720/economics/… Student loans were introduced in 1999 and were supposed to be "free" as their interest was pegged to inflation. If I can find a graph going back to 1999 and a notable source I'll turn this into an answer. Or if anyone else can do the hard work... :)
    – Jontia
    May 24 at 10:15

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The intention was to make the loans more progressive. The current student loans system was introduced in 2012 and implemented much of the proposals set out in the Browne Report, published in 2010.

The reason given for the use of an interest rate tied to inflation, rather than the Bank of England base rate, was that the loans should be based on the Government's cost of borrowing (as it's the Government providing the loan) - which is linked to RPI plus a certain percentage on index-based gilts. Browne dismissed the idea of financing loans from the private sector by predicting that banks would only agree to lend to students with a poor or blank credit history if they obtained a government subsidy, which would work out more expensive than direct government borrowing; "Government's cost of borrowing the funds to make student loans will always be lower than that of banks."

The interest rate on Plan 1 loans, taken out before the 2012 reforms, was the lower of either RPI or the base rate plus 1%. This, according to the Browne Report, created "perverse incentives around loan take up and fee deferral".

The current system does have some attractive features but it does not produce progressive effects. No students pay any interest on their loans. This means that even the wealthiest students after graduation receive a subsidy from Government – typically £3,000 – whereas that subsidy could be targeted on students on lower incomes. Wealthy students and families who understand the way the subsidy works realise they are being paid by the Government to borrow money and some will do so regardless of whether they have a genuine need.

By contrast – because the current system is poorly understood – many other students and their families are worried by the fact that they run up debt by going into higher education. In these discussions of debt, student loan obligations are still grouped alongside credit card debts and commercial mortgage style loans, as if they are all the same.

Browne's rationale was that low earners (currently those earning £27,295 or less) would accrue no further debt in real terms, while the system would incentivise higher earners and those with wealthy families who could afford to pay upfront to do so.

Families with high household incomes will be more likely to pay upfront voluntarily and graduates with very high earnings will be more likely to choose to make early payments to clear their obligation. Both of these behaviours will ease the cash borrowing requirement for Government, focus the Government support for students on those who need it and make the Student Finance Plan as a whole more sustainable.

It will mean that the student from a wealthy household who goes on to become a high earning graduate will no longer benefit from any public subsidy. Even if this student took up the full amount of maintenance loan for the costs of living and paid no fees upfront, the public purse will receive in time payments equal to the net present value of the costs paid by Government upfront.

At the other end of the earnings scale, the targeted interest rate subsidy means that the outstanding balance of low earners will not grow in real terms – and, if they never earn enough to pay back the costs of living and learning, then after 30 years these will be written off by Government.

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    I think this answer rather buries the lead. It seems obvious, particularly given other policies, that the primary motivation for the changes in the student loan scheme was to reduce government expenditure, by preventing government credit being "inflated away". It is true that the changes also made the system more progressive, in some sense, but this was a secondary, more politically palatable, effect. May 25 at 11:34
  • Yup... Tories never do anything for the good of society, they do it for the good of their own pockets.
    – Ian Kemp
    May 25 at 11:40
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    The Browne Review was conducted by Lord Browne, a cross-bench peer, and commissioned by the Labour government - the recommendations were implemented by the Conservative/LD coalition; I don't think it's fair to say that this policy was solely a Tory invention.
    – CDJB
    May 25 at 12:30

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