The education of their children is a critical goal for almost all Indian parents.
However, while providing the best education is priority, not many parents may actually be able to meet this goal.
This is because the cost of education has been spiralling over the years, with education inflation pegged at a whopping 10%.
A case in point: fees for a postgraduate programme at the IIMs have increased by up to 150% over the past 10 years (see table).
Higher education expenses are spiralling
Galloping inflation can make an education loan a necessity.
Starting to save early is critical. If parents start to save for their child’s education immediately after the birth of the child, they would have 18 years to save for graduation and 21 for higher studies. “Parents should keep a separate education corpus and start early, so that the power of compounding can work,” says Naveen Kukreja CEO & Co-founder, PaisaBazaar. The amount to be kept aside for this critical goal will balloon with every year’s delay (see chart).
To accumulate Rs 1 crore, you need to start early
Amount to be saved per month will zoom with delay.
|Years to invest||Investment needed per month (Rs)|
Assuming annualised return of 12%
However, despite starting early, one can still fall short of the required corpus. This is where education loans come in. As a parent, you should not baulk at the idea of taking this loan because not only does it help to upskill a child, it also comes with attractive tax benefits. In this week’s cover story, we will look at why an education loan makes sense today, what you need to consider while taking such a loan and the pitfalls to watch out for.
Bridge the shortfall
Spiralling costs is not the only reason why parents may fail to accumulate adequate money for their children’s education. A shortfall can occur because of a change in the nature of the goal. For instance, you may have budgeted for sending your child to one of the best institutes of higher learning in India, only to have your child opting for higher studies abroad. However, this possible shortfall is no excuse for not planning early. An existing education corpus makes it easy to get an education loan. “It will be easy to get a loan if you are only asking for a part of the cost and not the full cost,” says Amol Joshi, Founder, PlanRupee Investment Services.
The shortfall may also be due to the other expenses you did not foresee at the time of planning. For instance, most parents consider tuition fees, exam fees and hostel expenses while planning, but tend to forget about living expenses and the like. If the child goes to study abroad, the living expenses would be steep. “Assume that your ward gets 6 months to search for a job after completing a course. Since they will be staying outside the campus during this time, their expenses will be very high,” says Shilpa Wagh, Sebi registered investment adviser and fee only planner. Since no financial institution will fund these post-course expenses, parents must keep aside a part of the savings to fund these, while relying on the education loan to meet the cost of tuition fees.
Also read: Do’s and dont’s while taking education loan
Tax deduction for interest under Section 80E is the main advantage of an education loan. This deduction is available to the parent and the child, depending on who repays the loan. “Education loans offer a good tax planning opportunity. Since the entire interest can be deducted under Section 80E, the actual cost of the loan becomes much lower,” says Rohit Shah, Founder & CEO, Getting You Rich.
Repaying an education loan at the start of their career is a good way to instil financial discipline in young people. Since taking an education loan and repaying it on time also helps to establish credit scores, several parents, even those who can pay, insist upon their children taking this route. “The loan repayment responsibilities are being seen by numerous parents as an opportunity to inculcate the habit of financial discipline in their children and to help them build their own credit history,” says Arijit Sanyal, CEO, HDFC Credila.
Young people are also becoming independent and want to fund their higher education even if their parents have the money. “Education loan is good thing and I have taken an education loan personally. Why should parents take all the responsibility? It is time students take responsibility of their higher education costs,” says Adhil Shetty, CEO, BankBazaar.
WHAT TO LOOK FOR
This is the most important factor when it comes to choosing any loan and an education loan is no exception. Education loans in India don’t come cheap (see chart). “Since the aggregate NPA of educational loan is very high—9.5-10%—banks charge a higher interest,” says C. S. Sudheer, CEO and Founder, IndianMoney.com. However, banks reduce the interest by 1% if the interest is paid while the child is studying and the loan is repaid without any default thereafter.
Education loans don’t come cheap
The cost of an education loan is high because of the high rate of defaults.
Compiled by: ETIG Database
The institute of choice also has a bearing on interest rates (see chart). Banks readily give loans for those opting for premier institutes at low interest rates, because the employment opportunities for pass outs from these institutes are many. “The risks increase when students opt for lesser known institutes, and the interest rates charged are higher,” says Prashant Bhonsle, CEO-Students Loans, InCred. Most institutions offer special rebate of 25-50 bps for the girl child.
Students getting into prestigious foreign universities also have the option of loans from foreign institutions. “Since the interest on loan given by foreign institutions will be lower, students should consider this option,” says Shah.
Banks charge lower interest for premium institutes
Interest is low as chances of landing a job is higher
Effective interest rate on SBI education loans (%)
*This list includes top IIMs, ISB and XLRI
Since defaults are common, public sector banks usually insist on collateral for loans above Rs 7.5 lakh. Though several financial institutions provide education loans without collateral or mortgage, it is better to provide one to reduce interest costs. Mumbai-based K.R. Suresh, 61, (see picture) took an education loan of Rs 40 lakh in 2018 from Punjab National Bank to fund his daughter’s higher studies in the US. He put up his flat as collateral for the loan and is paying an interest of 10.25%.
Accepted collaterals include a house, a plot or fixed deposits. “It makes sense to use money lying in FDs with 6% interest, rather than take education loans at 11% using it as collateral,” says Shah.
In pic: K.R. Suresh, 61, Mumbai
The retired PSU employee put up his flat as collateral to take a Rs 40 lakh loan in 2018 for his daughter Suchetha’s higher studies in Syracuse University iSchool in the US. The interest rate is variable, having changed from 10.3% in the first year to 10.25% in the second. He is servicing the interest component now so that the repayment burden on his daughter is less.
3. Co-borrower or guarantor
As a standard practice, most financial institutions insist on a parent or guardian as the co-borrower/guarantor. The number of years of service of parents plays an important role here. For instance, Pune-based Shashank Shukla, 27, (see picture) was forced to pay 15% interest on his education loan. “Since my father is about to retire, the lending bank did not consider him as a loan guarantor and charged me higher interest rates,” he says.
In pic: Shashank Shukla, 27, Pune
He took an education loan of Rs 33.75 lakh in 2019 to complete his MBA. He is paying a steep 15% interest as the lender refused to accept his father as a guarantor as he is due to retire in a year. The loan repayment tenure is 15 years.
4. Margin money
Check how much the financial institution will fund and how much you need to put in. Your contribution is known as the margin money. This requirement varies depending on the lending institution, amount of loan and place of study. For example, PSU banks usually charge 5% margin for loans above Rs 4 lakh for students studying at Indian institutes and 15% for studies abroad. Private players, on the other hand, are ready to fund without any margin requirements. However, make sure that you don’t pay higher interest just to avoid paying the margin.
Unlike other loans, EMIs don’t start immediately for educational loans. In addition to the course period, there will another moratorium period for looking for a job. This moratorium period usually varies between 6 and 12 months. If the parent pays interest during the course period and moratorium period, the EMI will be based on principal only. If the borrower decides not to pay interest, the same will be accumulated and EMI will be based on loan plus accumulated interest. Most Indian parents prefer to pay interest during the course time and Suresh is an example. “I can service the interest from my present earnings. This will reduce the buden on my daughter when she starts repaying the loan,” he says.
This is one area of an education loan that has seen a sea change over the years. The maximum duration institutions used to give loans for was 7 years, which has now been extended to 15 years. This has meant a reduced EMI. In other words, the child will be able to service the loan it even if the initial salary is low. Since there is no prepayment penalty, it is better to opt for the longest possible duration. However, some prefer to close the loan as quickly as possible. Suraj Parasramka, 48, (see picture) is a co-applicant for his son’s education loan. “Though the repayment period is 7 years, we want to repay it in 2 years,” he says.
In pic: Suraj Parasramka, 48, Kolkata
Parasramka took an education loan of Rs 40 lakh in August 2018 from Punjab & Sindh Bank for his son’s M.Tech in The Netherlands. The interest is 10%. He has been repaying the interest from Day 1. Though the loan tenure is 7 years, he intends repaying it in full within 2 years.
The documentation is similar to that of other loans. “Since lenders will check the credit score of the parent and student, the score should be good,” says Shetty. On an average, a credit score above 700 is considered good. The lenders will also insist on admission related documents. Papers related to the collateral will also need to be submitted. For example, if you are pledging your flat in a housing society, you need to submit documents like share certificate, original sale deed, no objection certificate (NOC) from the society, etc.
This is critical because most institutes will not give too much time to secure admission. PSU banks are as quick as private lenders when it comes to disbursing home and personal loans, but not education loans. This means, you need to start the process a early.
Taking pre-approval and keeping the tentative loan ready is one way to speed up the process. Several foreign institutes insist you demonstrate the ability to pay fees and pre-approved letters come in handy then. However, the final disbursement happens only after your ward gets confirmed admission.
Diversifying your loan application can be another strategy. Approaching just one financial institution is a mistake. “To avoid last minute rush, it is better to start the process with 2-3 institutions simultaneously,” says Bhonsle. Since 90% of the documentation will be similar, this will not be an additional burden. However, you may have to pay processing fees to all the institutions.
Though education loan is a good option, don’t treat it as the only source of funds. Most universities offer scholarships for deserving candidates. It is important for students to explore such options before opting for a loan. Most foreign universities allow postgraduate students to take up campus jobs and this can take care of a major portion of living expenses.