Plans to penalise those who pay off student loans early seem likely to be ditched. But would it be wise to try and pay the government back before you need to ?

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Ministers were set to introduce a penalty for graduates who repaid their student loans early. Although the details of the new system had not yet been finalised, they were considering introducing a scheme in which graduates who repaid loans early, either through earning high incomes after graduation or because of family or other wealth, would pay a levy of around 5 per cent.

The penalty, the level of which had not yet been fixed, was proposed as a way of recouping costs lost through graduates avoiding interest repayments they would have incurred had they paid off their loans over the full 30-year term. First floated in a consultation launched last year, they were proposed by the Lib Dems as a way of making the repayments system more 'progressive'.

The consultation document suggested that it is "important that those on the highest incomes after graduation are not able unfairly to buy themselves out" of higher contributions towards the student loans system.

But it is understood that the government no longer plans to introduce the charges, with ministers expected to announce next week that student loans repayments will continue as under the current regime. The arrangements, due to come into effect for students entering university this September, will mean that graduates who go on to earn £21,000 or more will begin to pay back their loans with interest set at the rate of inflation plus up to 3 per cent from April 2016.

Lib Dem deal

The proposals for an early payment penalty were reportedly shelved as part of a political trade-off between the Tories and the Lib Dems, after Prime Minister David Cameron backed down over Business Secretary Vince Cable's choice of Professor Les Ebdon to head the Office for Fair Access (OFFA) despite fierce Conservative opposition to his appointment.

"Early repayment penalties ultimately risk making the student loans system more regressive." Liam Burns, National Union of Students

A Downing Street source told The Telegraph: "The Lib Dems were very keen to appoint Ebdon and we felt very strongly about penalties for early repayment of loans. This is hopefully good news for tens of thousands of families, as well as many Conservative MPs who had raised concerns about the penalties."

Whitehall sources have suggested that the government expect they will not recoup around 30 per cent of funds loaned under the system, either because debts are written off after 30 years, or because borrowers are unable to repay loans or interest due to unemployment or ill health.

However opponents of the penalty argued that those likely to repay early were actually the debt-averse poorer graduates, rather than wealthy earners. They also dispute the government's assertion that they will miss out on 30 per cent of funds, saying this estimate was based on previous rates of interest which no longer apply.

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'Tax the rich'

The think tank, CentreForum, welcomed news that the plans would be dropped, saying that early repayments do not demonstrate high incomes. They pointed to figures which suggest that the median income of those making additional repayments under the current system is £18,400, and suggested that increasing income tax on high earners would be a better way of ensuring that richer people contribute.

Chief economist, Tim Leunig, said of the decision to scrap the proposed penalty: "This is the right decision taken for the right reasons. Evidence shows that the students who repay their loans early are not the wealthiest, but the most debt averse. Students should not worry about taking a loan from the student loan company. Equally government should not penalise those who want to get out of debt for whatever reason."

Read more: Can't afford a gap year? Think again 

The whole debate over penalties for early payment was criticised by the National Union of Students (NUS) which points out that graduates could use their money more wisely.

Liam Burns, president of the NUS, said: "Early repayment penalties ultimately risk making the student loans system more regressive, but the issue of whether they should be barred or encouraged is a smoke screen that obscures the truth about paying back earlier than required.

"Paying back early is rarely a rational decision for those who have saved money for college or have a little bit extra to spare and most would be better off investing it in an ISA than handing it to the Student Loans Company.

Students at the University of Birmingham pose for a group photograph as they take part in their degree congregations on July 14, 2009 (Getty)

"In reality graduates shouldn't be able to repay early unless that repayment is over half of what is owed. That way debt averse low earning graduates won't be duped into throwing away capital earned early on in life when they might not have had to pay that amount at all."

"Evidence shows that the students who repay their loans early are not the wealthiest, but the most debt averse." Tim Leunig, CentreForum

From September students will be able to take out loans to cover their annual tuition fees bill of up to £9,000 as well as their living costs.

From April 2016, those earning £21,000 or more a year will pay 9 per cent of their income in monthly payments. Interest rates vary, from being pegged at the rate of inflation for those on the £21,000 threshold, with additional payments of up to 3 per cent on a rising scale for those earning £21,000 to £41,000.

Graduates who earn £41,000 or more will pay interest rates equal to the rate of inflation plus 3 per cent.

The fees are being introduced despite mass student protests in 2011.

'Consultation closed'

A No 10 spokesman said: "The consultation has now closed and we will come forward with our response shortly."

As the director general of Offa, Prof Ebdon will be responsible for ensuring the introduction of higher tuition fees do not deter students from low-income backgrounds from going to university.

His appointment is said to have been opposed by Education Secretary Michael Gove who is reported to believe that he was more interested in social engineering than promoting excellence in universities.

That view was echoed by Conservatives on the Commons Business, Innovations and Skills Committee, which last week called on the government to reopen the selection process following a pre-appointment hearing with Prof Ebdon.

Loans and repayments: a breakdown

For people borrowing £10,000 a year, which is higher than most fees and allows some borrowing for living costs, according to the government's survey based 4,000 person simulation:

The bottom third of graduates - consistent low earners, those who work part time for part of their career, those who have spells of unemployment, and those who die early - will pay back £12,438 of what they borrow, taking into account inflation

The middle third pay back £24,981 of £30,000

The top third pay back £30,637 of the £30,000 borrowed

The richest tenth pay back £31,014