Tips to manage your education loan burden
While taking an education loan is easy, paying back requires careful planning. Student borrowers get many relaxations which can be used to make the repayment smoother.
Education is expensive, especially if one is aiming for a premium institution or a foreign degree. Education loans can be a big help.
According to Google AdWords Keyword tool, used to track internet search volumes and advertising, over one lakh people from India key in the words 'education loan' or similar phrases every month on the search engine.
Student loans have grown more than ten times since 2004, when they were introduced in the Union Budget by then Finance Minister Yashwant Sinha.
A report by Esprito Santo Securities reveals that education loans grew 35 per cent annually between 2004 and 2012. Banks expanded overall credit by 23 per cent in the period.
Education loans are part of the priority lending category (along with housing loans). The government insists the facility should not be denied to any student who meets the parameters.
While taking an education loan is easy, paying back requires careful planning.
DO NOT DEFAULT
Along with an increase in lending over the years, there has been a sharp rise in the number of defaults.
A default spoils the credit score of both the student and his parents (usually co-borrower). If equated monthly instalments , or EMIs, are overdue for 90 days, the bank classifies the loan as a non-performing asset. The borrowers will not only come in the bad books of banks, if the loan amount is higher than Rs 7.5 lakh, the collateral will be at risk as well.
REPAYMENT STRATEGY
Repayment starts after a 'moratorium period' or 'repayment holiday', that is, one year after the end of studies or six months after getting a job, whichever is earlier. The borrower must have a repayment strategy in place before EMIs start.
CAPITALISE ON PROVISIONS
Student borrowers get many relaxations. These can be used to make the repayment smoother.
Start by reducing expenses. Margin money-a percentage of expenses that you pay while the bank pays the rest-is required on all loans above Rs 4 lakh. The rule is 5 per cent for studying in India and 15 per cent for studying abroad. However, many banks relax this rule for meritorious students.
Women can seek a lower rate as they are eligible for a 0.5 per cent concession. Banks also have special schemes, including interest subvention, for economically weak and differently-abled students.
Also, the fee is usually paid in tranches. "If possible, do not take the entire loan in one go but in instalments. This will reduce the interest burden," says Anil Rego, CEO and founder, Right Horizons, a wealth planner.
MAKE USE OF THE MORATORIUM PERIOD
Repayment does not start immediately. The extra time can be used to build a corpus. "The money can be either used for partial pre-payment or EMIs," says Rego.
You can also repay some interest during the study period to lower EMIs. The bank starts levying interest from the time of disbursement at the end of each course year or semester. The amount keeps adding up, increasing the debt burden.
However, if you pay simple interest on the principal during the study period, your EMIs will be reduced to a large extent. Many banks also give a 1 per cent interest concession to those who repay the interest debited during the moratorium period.
PAY AS YOU EARN
It will be nice if your bank gives you the option of income-linked repayment. Some education loan programmes in the US offer an incomesensitive repayment model where EMIs increase (or decrease) with income. At present, the Indian Banking Association's model education scheme has no provision for this. Banks also do not offer this option, mainly due to lack of data and technology. While Prashant A. Bhonsle, country head, Credila Financial Services, agrees it's a good model, he says it will be difficult for the lenders to keep track of the different accounts.
"Monitoring changes in compensation of such a large number of borrowers on an ongoing basis is difficult for lenders," says Bhonsle.
However, a similar but simpler model may soon be available. Data show that salaries are usually low in the first three years of employment and rise fast after that.
The new system will, therefore, allow you to pay less in the first few years and more later. "This step-up EMI model will be easier for banks to handle and is a possibility in the near term," says Bhonsle.
TAKE CARE OF RATE FLUCTUATIONS
The interest rate is typically the base rate plus a fixed spread, say 1-2 per cent, that varies from bank to bank. So, it is a floating rate loan.
If you are earning enough and are able to save some money after paying the current EMI and other expenses, use the spare money to create a buffer in case of any increase in interest rate.
"A sufficient surplus should be maintained (at least three instalments) so that EMI servicing continues unhampered even in the event of a spike in expenses," says V N Kulkarni, chief counsellor, Abhay Credit Counselling, a trust sponsored by Bank of India.
SHOULD YOU PREPAY?
Considering that prepayment involves paying a penalty, you need a proper cost-benefit analysis.
"One must assess the opportunity cost (interest versus earnings possible on investments)," says Suresh Sadagopan, a CFP and Founder, Ladder7 Financial Advisories.
WHAT IF YOU DON'T GET A JOB?
Banks extend loans based on the capacity to repay. This is usually based on the employment potential of the student after completion of the course. However, what if the market is down and the borrower fails to get good income or a job?
Some banks allow loan deferment, but they are hard to convince. "For exceptional and genuine cases where the student is not getting a job due of macroeconomic conditions, lenders may consider extending the repayment period," says Bhonsle of Credila Financial Services.
Usually education loans have tenures of five-seven years. However, as per the guidelines, the tenure can be extended up to 10 years for loans up to Rs 7.5 lakh and 15 years for loans above it.
An extension of the moratorium period is allowed in case the student takes up higher studies immediately after completing the course.
"The commencement of repayment will be shifted to six months from employment or one year of completion of the course, whichever is earlier, without treating the change as restructuring. This will be irrespective of whether the student has taken fresh or top-up loan for higher studies or not," says Ravishankar S, general managerplanning and development, Lakshmi Vilas Bank.
Banks also give an extension if the student is unable to complete the course on time for reasons beyond his/her control. The maximum extension in such situations is two years.
According to Google AdWords Keyword tool, used to track internet search volumes and advertising, over one lakh people from India key in the words 'education loan' or similar phrases every month on the search engine.
Student loans have grown more than ten times since 2004, when they were introduced in the Union Budget by then Finance Minister Yashwant Sinha.
A report by Esprito Santo Securities reveals that education loans grew 35 per cent annually between 2004 and 2012. Banks expanded overall credit by 23 per cent in the period.
Education loans are part of the priority lending category (along with housing loans). The government insists the facility should not be denied to any student who meets the parameters.
While taking an education loan is easy, paying back requires careful planning.
DO NOT DEFAULT
Along with an increase in lending over the years, there has been a sharp rise in the number of defaults.
A default spoils the credit score of both the student and his parents (usually co-borrower). If equated monthly instalments , or EMIs, are overdue for 90 days, the bank classifies the loan as a non-performing asset. The borrowers will not only come in the bad books of banks, if the loan amount is higher than Rs 7.5 lakh, the collateral will be at risk as well.
REPAYMENT STRATEGY
Repayment starts after a 'moratorium period' or 'repayment holiday', that is, one year after the end of studies or six months after getting a job, whichever is earlier. The borrower must have a repayment strategy in place before EMIs start.
CAPITALISE ON PROVISIONS
Student borrowers get many relaxations. These can be used to make the repayment smoother.
Start by reducing expenses. Margin money-a percentage of expenses that you pay while the bank pays the rest-is required on all loans above Rs 4 lakh. The rule is 5 per cent for studying in India and 15 per cent for studying abroad. However, many banks relax this rule for meritorious students.
Women can seek a lower rate as they are eligible for a 0.5 per cent concession. Banks also have special schemes, including interest subvention, for economically weak and differently-abled students.
Also, the fee is usually paid in tranches. "If possible, do not take the entire loan in one go but in instalments. This will reduce the interest burden," says Anil Rego, CEO and founder, Right Horizons, a wealth planner.
MAKE USE OF THE MORATORIUM PERIOD
Repayment does not start immediately. The extra time can be used to build a corpus. "The money can be either used for partial pre-payment or EMIs," says Rego.
You can also repay some interest during the study period to lower EMIs. The bank starts levying interest from the time of disbursement at the end of each course year or semester. The amount keeps adding up, increasing the debt burden.
However, if you pay simple interest on the principal during the study period, your EMIs will be reduced to a large extent. Many banks also give a 1 per cent interest concession to those who repay the interest debited during the moratorium period.
PAY AS YOU EARN
It will be nice if your bank gives you the option of income-linked repayment. Some education loan programmes in the US offer an incomesensitive repayment model where EMIs increase (or decrease) with income. At present, the Indian Banking Association's model education scheme has no provision for this. Banks also do not offer this option, mainly due to lack of data and technology. While Prashant A. Bhonsle, country head, Credila Financial Services, agrees it's a good model, he says it will be difficult for the lenders to keep track of the different accounts.
"Monitoring changes in compensation of such a large number of borrowers on an ongoing basis is difficult for lenders," says Bhonsle.
However, a similar but simpler model may soon be available. Data show that salaries are usually low in the first three years of employment and rise fast after that.
The new system will, therefore, allow you to pay less in the first few years and more later. "This step-up EMI model will be easier for banks to handle and is a possibility in the near term," says Bhonsle.
TAKE CARE OF RATE FLUCTUATIONS
The interest rate is typically the base rate plus a fixed spread, say 1-2 per cent, that varies from bank to bank. So, it is a floating rate loan.
If you are earning enough and are able to save some money after paying the current EMI and other expenses, use the spare money to create a buffer in case of any increase in interest rate.
"A sufficient surplus should be maintained (at least three instalments) so that EMI servicing continues unhampered even in the event of a spike in expenses," says V N Kulkarni, chief counsellor, Abhay Credit Counselling, a trust sponsored by Bank of India.
SHOULD YOU PREPAY?
Considering that prepayment involves paying a penalty, you need a proper cost-benefit analysis.
"One must assess the opportunity cost (interest versus earnings possible on investments)," says Suresh Sadagopan, a CFP and Founder, Ladder7 Financial Advisories.
WHAT IF YOU DON'T GET A JOB?
Banks extend loans based on the capacity to repay. This is usually based on the employment potential of the student after completion of the course. However, what if the market is down and the borrower fails to get good income or a job?
Some banks allow loan deferment, but they are hard to convince. "For exceptional and genuine cases where the student is not getting a job due of macroeconomic conditions, lenders may consider extending the repayment period," says Bhonsle of Credila Financial Services.
Usually education loans have tenures of five-seven years. However, as per the guidelines, the tenure can be extended up to 10 years for loans up to Rs 7.5 lakh and 15 years for loans above it.
An extension of the moratorium period is allowed in case the student takes up higher studies immediately after completing the course.
"The commencement of repayment will be shifted to six months from employment or one year of completion of the course, whichever is earlier, without treating the change as restructuring. This will be irrespective of whether the student has taken fresh or top-up loan for higher studies or not," says Ravishankar S, general managerplanning and development, Lakshmi Vilas Bank.
Banks also give an extension if the student is unable to complete the course on time for reasons beyond his/her control. The maximum extension in such situations is two years.
GROWING DEFAULTS {mosimage} STRICTER RULES AHEAD Borrowing was relatively easy so far. There has been a gradual increase in outstanding education loan amount. According to an Esprito Santo Securities's report, the amount grew from Rs 4,600 crore in 2004 to Rs 50,200 crore in 2012, indicating more loans were disbursed. However, students are increasingly defaulting. The government is taking protective measures such as the formation of a credit guarantee fund. Under this, banks will be guaranteed 75 per cent of the loan amount in case a student defaults. However, this is only for loans up to Rs 7.5 lakh where there is no third-party guarantee or collateral. The banks are raising the shield as well. This means stricter eligibility criteria for borrowers. The Indian Banking Association (IBA), the industry lobby, has set up an expert committee to modify the education loan scheme. It plans to introduce a rating system for colleges and institutions. This will be based on things like their reputation and placement records. "Banks have data on likely salary packages after finishing the course and they take a call based on such information as well," says Rishi Mehra, founder, deals4loan.com. This means you'll get a loan easily for an MBA from the IIMs whereas getting funds for the same degree from some littleknown institutes will be extremely difficult. Moreover, at present, no collateral is required for loans up to Rs 7.5 lakh. But the IBA plans to change this rule a bit; banks might ask for some security in cases where admission is based only on merit. |
