Around 65,000 spaces - for students who gain at least two A grades and a B at A-level - will be up for grabs, under the proposals.
And a further 20,000 places will be fought for by universities and colleges that offer "good quality" courses for £7,500 or less.
The proposals were key measures of today's higher education White Paper, aimed at opening up the sector and giving more power to students.
The reforms are tied to the Government's plans to triple tuition fees to £9,000 from next year.
Announcing the proposals, Universities Minister David Willetts said the Government was "liberating" student places from 2012, and more would be contested in the future.
He said: "We have tried in the first year to get the balance right between significantly opening up the system - it's about one in four places contestable - without imposing too much turbulence in the system.
"For the future we want go further, year on year."
Mr Willetts estimated that 350,000 new students will start courses in autumn 2012, who will be eligible for fees and loans.
Of these, 85,000 places in total will be contestable by institutions, he said.
He insisted that the sector could handle the change, but acknowledged that in future, universities could find they are left with unpopular courses that are unfilled.
"There may be some that discover students really like some courses that can expand, and have really low demand for other courses," Mr Willetts said.
It could mean that courses that fail to attract students could be forced to close down.
Plans to hand 20,000 places to universities and colleges that charge tuition fees of £7,500 or less are likely to be seen as an attempt by Government to encourage institutions to keep fees low.
The places are more likely to go to further education colleges offering degree courses, or private institutions, as so far every English university has said it wants to charge more than £6,000.
Martin Doel, chief executive of the Association of Colleges (AoC), said: "Today's White Paper recognises the benefits of affordable, quality college higher education in England by providing 20,000 extra student places available for institutions setting 2012 course fees under £7,500. The vast majority of further education colleges teaching HE will be charging £6,000 or below next year.
"While we would have liked to see even more places available and a price threshold lower than £7,500 as a welcome first step in creating more affordable places, in a way that is flexible and leads to improved life and career prospects, we understand the pressures on the public purse that necessitate a limit on additional places."
Overall, the White Paper says that 85,000 places will be made contestable by "unconstrained recruitment of the roughly 65,000 high-achieving students, scoring the equivalent of AAB or above at A-level and creating a flexible margin of about 20,000 places to reward universities and colleges who combine good quality with value for money and whose average tuition charge is at or below £7,500 per year."
Under today's reforms graduates would be allowed to pay back their loans early, but the Government said it will consult on how to do this.
The document also says it will look at whether students should apply for university after receiving their A-level results.
Such a move would mean a major revamp of the system, with students sitting their A-levels earlier in the school year to allow more time to apply.
Ministers said they would not look at so-called post qualification application (PQA) or a hybrid system until after UCAS has completed its review of the admissions process.
Today's package of reforms also contains plans to:
:: Allow employers and charities to sponsor student places outside the current cap. The measure proved controversial when it was mooted last month as it was suggested that the Government was considering allowing rich students to "buy" places. The claim was dismissed outright by ministers.
:: Universities will be told to publish more information for would-be students on student satisfaction, job prospects and future earnings, the expertise and qualifications of teaching staff and the number of lecture hours for a course.
:: Student charters, stipulating what the university intends to provide, could be made compulsory.
:: The Office for Fair Access (OFFA) will be strengthened and asked if it has enough powers. The watchdog assesses whether institutions are doing enough to meet their agreements on recruiting poorer students.
James Ashton-Bell, president of the University of Bristol Students Union, said the Government's plans would only make the university more exclusive.
"These plans will undermine the Government's stated aim of widening access to our best universities," he said.
"They will encourage universities like Bristol to become more exclusive and damage longstanding work to ensure fair access to the best students - whatever their family background.
"They directly contradict David Willets' earlier insistence that universities should do more to ensure they considered applicants in a rounded way when making offers of places."
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