As higher education gets privatised in India leading to a sharp rise in tuition fees, it has become increasingly difficult for a salaried family to fund their children's college and university education from regular income. This has created a big market for education loans and it’s quite common for students to finance their graduate or postgraduate studies through an education loan.
Education loan becomes even more important if one opts for a foreign university for higher education, which is now quite common among students in India's big cities. The overall cost of overseas education can be many times higher than in India, leaving students and their families with little option but to opt for an education loan to fund their studies.
While an education loan is now as common as say a home loan, it can be tricky.
Here are five things to keep in mind if you are planning to apply for an education loan for higher studies.
1. Do you really need an education loan? For all the play of words and a marketing push by the lenders and the government, an education loan is ultimately a personal loan. This means that the interest rates on education loans are much higher than say home loans or even car loans. In fact, many private-sector lenders charge as high as 14 percent interest on education loans – nearly twice the prevailing interest rate on home loans.
So before jumping for an education loan to fund admission in your dream college or a course explore all other options such as scholarships, public or government-funded college with lower fees, borrowings from family or friends or even opting for a course or degree that costs less.
2. Is the degree or the course worth it? It’s never a great idea to start your adulthood with a long-term debt burden loan on your head. Your first job and the first salary cheque should be about the freedom to choose and spend rather than an escrow account for the bank to collect its dues.
A typical Indian has a working life of around 30-35 years. So if you start your working life with an education loan, you are likely to retire in debt assuming that you will have to opt for a car loan and a home loan later in your life. This is not a great financial situation to be in.
Additionally, the financial pressure to repay the education loan may force you to make wrong career or job choices which may prove costly in the longer term. So think through the life-cycle cost of the education loan before you decide to sign on the dotted line.
Banks and lenders push education loans like their other personal loan products but as a borrower, you should know that it’s a completely different financial beast. While a home or car loan is a lien on your current earnings and cash flows, an education loan is a lien on your future. This requires a different kind of homework and future scenario building than typical retail loans.
3. There may be cheaper options than education loans. As discussed earlier, education loans are expensive with high-interest rates that translate into higher EMIs. Currently, home loans are the cheapest with interest rates as low as 6.5 per cent.
The interest rate on top-up as well as the loan against property is just a notch above the interest rate on home loans, making them very affordable.
Another option would be a gold loan if your family has enough gold jewellery.
As a thumb rule, a secured loan where borrowers pledge a physical asset such as real estate or gold with the bank against the loans is always cheaper than unsecured or collateral-free loans such as education loans.
4. Calculate the tax savings on education loans. Just like a home loan, the government provides a tax deduction on education loans. The EMI paid on education loans taken for higher studies is deductible under Section 80E of the income tax act. The yearly limit for deduction or the tax break is Rs 40,000 that includes both the principal and the interest. The deduction is available for a maximum of eight years starting from the day you start repaying.
For example, a person in the income-tax bracket of 20 percent will save a maximum of Rs 8000 per year in income taxes or Rs 64,000 over eight years. This translates into total savings of 8-10 percent on total EMIs. Take this saving into account while calculating the life-cycle cost of an education loan.
Remember, there is no tax deduction if you take a top-up home loan or loan against property to fund higher education. The best way to optimise your savings would be to limit the education loan so that the annual EMI on the loan is closer to Rs 40,000 per year and raise additional amounts through a top-up loan or loan against property.
5. There is no standard interest on education loans. There is no standard or benchmark interest on education loans and the interest rate and loan conditions vary greatly from one lender to the other. But there are some general rules that govern the entire industry. As a thumb rule, the interest rate is the lowest for courses at the reputed colleges and universities such as the Indian Institute of Technologies (IITs) and the Indian Institutes of Management (IIMs). Similarly, banks charge lower interest rates for professional courses such as engineering or management compared to postgraduate degrees in humanities or social sciences. So plan accordingly.
However, in lieu of lower rates, PSBs may ask for a greater amount of documentation and collateral such as property or a personal guarantee from your parents. So do thorough research and then shop around to get the best deal for yourself.
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).