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Factors to consider before taking an education loan

Opportunity costs must be considered when you are mulling a loan because the interest paid on student loans is completely tax-deductible.

Getting a good college education can be one of the most transformative experiences of anyone’s life. However, with education costs rising steeply, it is not always possible to cover the college costs with your savings or scholarships. In such scenarios, students are increasingly turning towards education loans to help fill the gap. With so many options in the market and other complexities, it is often tough to navigate them.

To assess loans objectively, you need to go beyond simple default rates and repayment schedules. You need to delve deeper into the course you are planning on undertaking and evaluate it against the total loan amount you are seeking. Finally, you need to honestly assess your ability to pay it back. It’s the first big financial decision you will make to kick-start your life, so it is imperative to give it serious consideration.

To begin with, you must consider the potential of the course and institute you are opting for. Research the college/ institute you are considering thoroughly, ensure it is not blacklisted by any bank for loans. Many banks have a pre-approved list of accredited universities. Follow this up by assessing your job prospects upon graduation. How much money you are likely to draw after you graduate should be a determinant for your loan as returning the loan would be easier with better remuneration packages. Consider carefully how much you need to borrow.

Interest rates are determined by the loan amount – the larger the sum borrowed, the larger the payment period and lower the interest rates. Shorter-term loans appear heavy on the pocket but save you from paying large sums of money over a prolonged period.

In most cases of student loan payments—your payment money is applied first to the interest, and then to the principal amount you borrowed. In case of late payments, late fee payments are first considered during payoffs. As in other loans, when your principal reduces, so does the interest you pay, since most banks charge interest only on the remaining balance. Thus, over time, the ratio of your payments against the principal gradually becomes larger.

Evaluate how flexible the bank is about the moratorium period or extending the payment duration. It is good to plan and pay interest during this period to avoid interest getting accumulated. In some cases, you may want flexibility on the moratorium as you may be still sorting out your job situation.

Alongside the evident costs of higher education such as tuition fees and accommodation, another cost that students need to consider when availing of loans are the indirect or opportunity costs. So for instance, if you decide to drop a year to travel, you are not just spending on travel or food but also losing the money you would have earned if you were employed during that period.

Opportunity costs must be considered when you are mulling a loan because the interest paid on student loans is completely tax-deductible under Sec 80E, as long as the loan is taken from a scheduled bank or approved providers by the Income Tax department.

For instance, if a person has Rs 1lakh which could be invested to earn a return of 9000 at 9 per cent interest; Instead opts to take an educational loan for 1lakh – interest paid at a rate of 10 per cent per year would amount to 10,000. With a 20 per cent tax-saving bracket – they would save Rs 2080 thus effectively paying an interest of Rs 7920. So the opportunity cost would work out to Rs 1080. These numbers will change with returns earned, interest paid and tax bracket when the loan is being repaid. So while it is tempting to increase your monthly EMIs to be debt-free sooner, it is probably not the best decision in the long run. Nonetheless, it is not an easy question to answer.

There are many factors and variables to be considered before choosing to opt for a student loan and deciding on its payment schedule. However, what is most beneficial is to start investing early in long term instruments such as equity mutual funds, which in the first place can help you avoid taking the loan for studying further.

For example, you start investing Rs 10,000 per month today, for 10 years. At an average of 12 per cent p.a returns, you’ll have upwards of Rs 23 lakhs accumulated, which is good enough to manage an MBA in India.

By, Anup Bansal, Chief Investment Officer, Scripbox

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