Do not get stuck with an education loan, improve it
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Getting a loan can solve many of the challenges that arise from lack of financial resources. However, once the loan is approved and amount utilised, the bigger challenge of repaying that loan remains. Especially in big-ticket loans, the equated monthly instalments (EMIs) are a significant amount and failure to repay on time can not only jeopardise your credit profile but also put you in a debt trap. This holds true for education loans as well.
If you are looking for an education loan (read more here), it is good to know what to do once the money is in your hands: how to maximise its benefits through restructuring, refinancing and availing the tax benefits.
Refinancing and restructuring
When you apply for an education loan, it is possible that as a consumer, your bargaining power is limited and you have to accept all the terms and conditions laid down by the lender. However, once you have completed your education and are employed, then based on your earnings and risk-taking ability, you could be in a better position to negotiate the terms of your loan.
According to Amit Gainda, chief executive officer, Avanse Financial Services Ltd, a borrower can refinance her existing education loan with another lender at more favourable terms. Refinancing means, using another loan to repay the original lender. In this process, depending on the contract, a borrower may have to pay a processing fee to the new lender. “From the borrower’s point of view, if terms of the loan offered by the new lender are more favourable in terms of interest rate or tenure, then the borrower may look at refinancing,” said Gainda.
Reduced interest is not the only benefit of restructuring a loan. Depending on your career prospects after finishing the course, for which you took the loan, you could also be in a position to refinance an existing secured loan, with an unsecured loan. While that could be beneficial in the long term, reduced interest rates would bring immediate relief.
Consider an education loan of Rs20 lakh at 12% interest, to be repaid over 9 years. Assuming that there are no processing fee and that interest repayment for period of study (say, first 2 years) has been done, you would need to pay about Rs9.66 lakh more in interest. However, with a job in hand (and better finances due to it), you are now in a position to negotiate better terms. If you are able to get refinancing at the rate of 10%, your interest outgo over the remaining 7 years of repayment would reduce by about Rs1.77 lakh.
Even before getting a job, you will find yourself in a position to negotiate better terms while taking a loan, if you get admission in reputed or highly ranked institutes. This is so because it assures the lenders about your employment prospects. On the other hand, you may have to pay higher interest rates if your institute does not figure among the highly rated ones. Refinancing a loan, after you get a good job, would be more advantageous in the latter case because that could mean a significant savings on your interest outgo, compared to the first loan.
But, what if a student is unable to complete the course within stipulated time? The Education Loan Scheme 2015 (amended 2016) by the Indian Banks Association, says that banks can extend the time for completion of course by the student. This would also mean an extension to the moratorium on repayment of principal amount. In case of unemployment or underemployment, banks can also consider giving two to three extensions of 6 months each to the moratorium period.
In this case, restructuring in the form of extending the tenure can also help. This will reduce the monthly EMI, but the total interest amount would go up.
As per section 80E of the income-tax Act, the borrower of an education loan can claim a deduction on the interest paid. Though there is no limit to the amount that can be claimed as deduction under this section, the deduction cannot be applied to the principal repayment, and can be claimed for a period of 8 years, or till the time the entire loan is repaid, whichever is earlier.
The borrower can avail tax benefits under this section for an education loan to support higher studies of self, spouse, children or for the student of whom she is the legal guardian. So, education loans taken for siblings or other relatives don’t qualify for section 80E benefits (read here).
Take for instance a Rs20 lakh education loan at an interest rate of 11.5%, assuming a 2-year period of study and moratorium and then repayment spread over 5 years. The interest payment each year will be Rs2.3 lakh. If the borrower is in the highest tax slab of 31.2% (effective rate after Budget 2018), she can save Rs71,760 in taxes. In order to claim this benefit, you need to get an interest payment certificate from your bank or the lending institution.
Though education loans from all banks are covered under this benefit, not all non-banking financial companies are. Do specifically check for this bit if you are seeking an education loan from an NBFC.
If you plan on making prepaying or foreclosing your education loan, give a thought to the tax benefits you would get if you continue with regular servicing of the loan. “Due to the income-tax benefit available for education loan on the interest component, there is a substantial tax saving and the overall interest (cost of loan) becomes quite low. So, typically students keep the education loan going instead of prepaying it in full,” said Ajay Bohora, co-founder, managing director and chief executive officer of HDFC Credila, an HDFC Ltd subsidiary that specialises in education loans.
However, if you plan to foreclose the loan, there is no pre-payment penalty.
Beware of your credit score
In most cases, an education loan is the first loan a student takes in her name. “So ensuring steady repayment and maintaining a good track record is important. Unless the repayment track record of the education loan is clean, there is a risk that the student might face challenges in availing other loans,” said Bohora.
If the repayment is regular and on time, you can benefit as you may not need to take other measures specifically to build a healthy credit history and credit score.
You can monitor your credit score for free by accessing your credit reports from the four credit bureaus each year (read how to access it here.