Graduates will be able to take a five-year “repayment holiday” on their student loans under an expansion of financial support aimed at recruiting more undergraduates.

John Denham, the Secretary of State for Innovation, Universities and Skills, said that the measure would enable graduates to take a break from repaying their loans either in a single five-year stretch or over short periods to help them at times of significant expense, such as when they were buying a house or starting a family.

Mr Denham said that he would also be increasing by 250,000 the number of students receiving nonrepayable grants for university living costs from September 2008.

Students will qualify for a full grant worth £2,825 a year if their parents earn less than £25,000 – up from the present level of £17,500. Those from families earning up to £60,000 a year will get some form of maintenance grant, up from £37,425 at present.

This will put an extra £1,100 a year in the pocket of a student from a household on £25,000 earnings and an extra £1,000 for a student from a family on £40,000 a year.

Mr Denham also announced that 16-year-olds who qualified for the means-tested Educational Maintenance Allowance – paid for staying on at school or college – would be given a guarantee of the amount of financial support they will receive if they choose to go to university at 18.

“To compete and prosper in this world . . . we must enable many thousands more people to study and graduate each year,” he told the Commons. “We cannot be satisfied when only 28 per cent of students come from low-income backgrounds. We are wasting the talents of too many young people for whom university study should be a realistic ambition.”

Bill Rammell, the Higher Education Minister, insisted that teaching money would not be raided to fund the proposals, which are expected to cost more than £400,000, although he would not say where the money would come from.

He added that the reforms were aimed at helping to achieve the government target of educating 50 per cent of 18 to 30-year-olds to degree level. Although student numbers have increased by more than 400,000 in the past decade, the rate of increase has slowed and participation rates have levelled out at 43 per cent.

The changes received a cautious welcome from student and university leaders. Some feared that the seemingly generous move was designed as a sop to pave the way for the Government to lift the £3,000-a-year cap on tuition fees and to scrap the zero interest rates on student loans when the system is next reviewed in 2009.

Others said that the reforms were aimed at softening up Brownites on the Labour back benches who had opposed the introduction of top-up fees.

Gemma Tumelty, president of the National Union of Students, said that offering potential students greater financial incentives should not come at the expense of graduates.

“We are reluctant to welcome the proposal [for loan repayment holidays] with open arms for fear that the sting will be the Government introducing commercial interest rates on student loans,” she said.

David Willetts, the Conservative universities spokesman, said that the loan-repayment holidays would ease a major anxiety of parents, who were concerned about how graduates repaying loans could get on the housing ladder. He expressed disappointment, that the Government was not providing extra support for part-time students, who were more likely to come from lower-income groups.

Steve Smith, chairman of the 1994 Group of universities and Vice-Chancellor at Exeter University, welcomed the extra money for poor students but cautioned against raiding university bursary schemes to fund it.

Explore Education

• Schools

• GCSE & A Level Results

• Good University Guide

• Sunday Times University Guide

• Student

• Young Times

Times recommends

• Google generation has no need for rote learning
• Left-handers do 'less well' in exams
• Nativity comic books for multicultural Britain