Student Loan Repayment with Interest
Last updated: June 2025 · 6 min read
Student loans in the UK work differently from other types of borrowing, but they're still subject to compound interest. Understanding how interest accrues on your student loan helps you make informed decisions about voluntary overpayments and financial planning after graduation.
This worked example uses a Plan 2 student loan (the most common for English and Welsh students who started university from September 2012) to illustrate how compound interest affects your total repayment.
Profile Summary
How Student Loan Interest Works
Plan 2 student loan interest is charged at RPI (Retail Price Index) plus up to 3%, depending on your income. While you're studying, it's RPI + 3%. After graduation, it scales based on earnings: at the repayment threshold it's just RPI, and at £49,130 or above it's RPI + 3%. With RPI at 4.3% as of early 2025, the maximum rate is 7.3%.
Crucially, interest compounds daily on student loans. Each day, 1/365th of the annual rate is applied to your outstanding balance. This means interest accrues on previously accumulated interest from the very start — unlike simple interest, which would be calculated only on the original loan amount.
Step-by-Step: First 5 Years
Let's trace what happens with a £45,000 loan, a starting salary of £32,000 (rising 3% per year), and a blended interest rate averaging 6.5% in the early years:
| Year | Salary | Annual Repayment | Interest Added | Balance |
|---|---|---|---|---|
| 1 | £32,000 | £423 | £2,925 | £47,502 |
| 2 | £32,960 | £510 | £3,088 | £50,080 |
| 3 | £33,949 | £599 | £3,255 | £52,736 |
| 4 | £34,967 | £691 | £3,428 | £55,473 |
| 5 | £36,016 | £785 | £3,606 | £58,294 |
Notice the pattern: the loan balance is growing despite making repayments. In the first five years, you've repaid £3,008 but £16,302 in interest has been added. The balance has increased from £45,000 to £58,294. This is compound interest working against the borrower — your repayments aren't keeping pace with the interest.
Will the Loan Ever Be Repaid?
For many graduates, the answer is no — and that's by design. Plan 2 loans are written off 30 years after the April following graduation. If your salary doesn't grow fast enough for repayments to exceed interest charges, the outstanding balance is simply cancelled. The Institute for Fiscal Studies estimates that around 70% of Plan 2 borrowers will have some or all of their loan written off.
For this example, our graduate would need to reach a salary of approximately £55,000+ for their repayments to consistently exceed the interest being added. At 3% annual salary growth from £32,000, that takes about 18 years. By then, the loan balance would have grown significantly, and there would be only 12 years of reducing payments left.
Should You Overpay?
Voluntary overpayments on student loans are generally not recommended for most graduates, because any remaining balance is written off after 30 years. If you're unlikely to repay in full, overpaying simply means you've paid money you didn't need to. However, very high earners who would repay in full may benefit from overpaying to reduce total interest costs.
Using the Rule of 72, at 7.3% interest the loan balance would double in approximately 9.9 years if no repayments were made. That rapid growth demonstrates why high-earner graduates sometimes choose to overpay — the interest cost of carrying a large balance for decades can be substantial.
Key Takeaways
- Student loan interest compounds daily, causing balances to grow rapidly — especially during low-earning years after graduation.
- For most graduates, repayments function more like a graduate tax (9% of income above the threshold) than a traditional loan.
- The 30-year write-off means many borrowers will never repay the full amount, making voluntary overpayments counterproductive in most cases.
- Higher earners should model whether they'll repay in full. If so, overpaying can reduce total interest cost. Our calculator can help model different scenarios.
- Understanding compound interest on debt is just as important as understanding it for savings. See compound vs simple interest for a broader perspective.
Frequently Asked Questions
Does the interest rate on student loans change?
Yes, the rate is recalculated each September based on the RPI figure from March. It can go up or down. For Plan 2 loans, the rate is currently capped at RPI + 3% (7.3% for 2024/25). From 2023, there's also an overall cap at the prevailing market rate for new borrowers.
What happens to my loan if I move abroad?
You must still make repayments based on your overseas income. The Student Loans Company sets income thresholds for different countries. If you fail to keep them informed of your income abroad, they can impose fixed repayment amounts.
Model compound interest on your own loan balance
Open the Compound Interest Calculator →This scenario is for illustrative purposes only and does not constitute professional financial advice. Student loan terms and interest rates are subject to change by the UK government.