A steady rollback in subsidies on higher education and the privatisation of the sector has led to a sharp rise in the cost of college and university education in India. This has made it difficult for middle-class and salaried families to fund their children's higher education from regular income. As a result, more and more parents and students are opting to fund their post-graduate and professional studies through education loans from banks and non-bank finance companies.
Education loans are even more popular among students opting for a foreign university for higher education. The overall cost of overseas education can be many times higher than in India, leaving students and their families with little option except an education loan.
On the face of it, higher education from a top-notch and credible university or institution is the best investment that a person can make for herself; but an education loan can become a financial millstone around the student's neck if not handled well.
Here are four 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 15 percent interest on education loans – nearly twice the prevailing interest rate on home loans.
At such a high rate of interest, the equated monthly instalment (EMI) on your education loan may consume most of your salary in the initial 5 to 7 years of your job.
So before jumping for an education loan to fund admission to the college of your dreams or university 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 degree that will not require a loan.
2. Mortgaging your future. 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. As the education loan is not backed by assets unlike a home or a vehicle loan, it makes it very difficult for the student or her family to default on the loan in the worst-case scenario. This turns an education loan into a mortgage on the student’s future which is very discomforting.
3. 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 check should be about the freedom to choose and spend rather than an escrow account for the bank to collect its dues.
If you start your professional life with a five or eight-year loan on your head, it will be tough for you to save and build a corpus for retirement or big-ticket purchases such as a car or a home.
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 you will buy a home with a 20-year loan, followed by a car loan that typically lasts for 5 to 7 years. This is not a great financial situation to be in.
Additionally, the financial pressure to repay the education loan may force you to make the 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.
4. Opt for cheaper options like top-up home loans and gold loans instead of education loans. As discussed earlier, education loans are expensive with a high interest rate that translate into higher EMIs. Currently, top-up home loans are the cheapest with interest rates as low as 8.5 percent.
This makes a top-up loan on an existing home loan one of the cheapest ways to finance education.
If your family has already paid the home loan, then you can opt for a loan against the property. The interest rate on the top-up loan as well as any loan against property is only 50-100 basis points higher than the interest rate on home loans, making them very affordable.
Another option would be a gold loan if your family has enough gold jewellery. The interest rate on a loan against gold jewellery starts at 9.5 percent and is most often cheaper than the interest rate on an education loan.
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.
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).
Also Read: Retirement planning: 5 tips to retire rich
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