Recently after securing admission into an MBA program, I was thinking about :
-whether to go for education loan
-to use it to what extent
For eg. if I have 4L of cash lying idle in my bank account, should I use some of this or should I go for loan of full amount. I searched around on the internet but couldn’t find something readily. So I thought of sharing my thoughts on this.
Before you begin your financial planning, keep in mind that most banks ask you to deposit "margin" money. What this means is that you won’t get the loan for full fees. A certain percentage(generally 5%) of overall expenses have to be borne by you. So in case of XLRI GMP(total fees 11.39), you will have to pay 5%= Rs 60K.
I realized that there were following considerations for evaluating education loans:
1. First go to this URL and try to get a sense of EMI you would pay after you pass out :
Calculator
Keep the ROI as 10.5%, tenure as 7(maximum possible) and play with other values. I realized that it doesn’t come cheap- Rs 10L loan for 7 years requires an EMI of Rs 16860.
2. Also, remember this EMI will be in addition to your EMIs for house and car if you are planning to buy them. These other EMIs can be in the range of Rs 30-40K for many of us.
3. But wait, before you get scared of the education loan, make sure you factor in the tax benefits. Here is the URL which describes them: Tax benefits
So, in short your interest payments(not the principal repayments) are fully exempted from tax calculation. Let’s calculate the tax savings:
| Year |
Total interest payment |
Total tax saving(30% slab) |
| 1 |
100,000 |
30000 |
| 2 |
90,000 |
27000 |
| 3 |
75000 |
22500 |
| 4 |
60000 |
18000 |
| 5 |
48000 |
14000 |
| 6 |
30000 |
9000 |
| 7 |
9600 |
3000 |
| Total |
4,16,000 |
1,25,000 |
So after reducing the tax benefit from the interest payments, the net “cost” of the loan is Rs 4,16,000 – Rs 1,25,000 = Rs 2,81,000. Or in other words, the effective ROI you pay for Rs 10L of principal is 7.5% which is 3% less than the rate of interest you borrowed the money at.
4. So a logical conclusion of our original question of whether to go for education loan becomes-
Can I make my extra money grow at a rate more than 7.5%?
The current FD rates are round about this same figure of 7.5%. But before you jump the gun, don’t forget that the interest earned on FDs(of less than 5 year duration) are taxable. So your effective rate takes a hit of about 1-2% points. So one should try to put the excess money in combination of following instruments:
- a. FDs ( totally risk free)
- b. Monthly Income Plans: Debt instruments + some equity component to take the ROI to about 12-15%. For further elucidation, I suggest this link: Deepak Shenoy on MIP vs FD
- c. Equity diversifies MFs.
Conclusion: Penny-wise it does make sense to go for education loans given you are ready to invest your excess money judiciously. Simply putting the money in savings account or putting it on FDs is not a bright idea. In the end, it is a matter of personal risk appetite.
I suggest one to go for education loans to the maximum extent you can handle psychologically. But don’t forget to send your saved money for some hard work in the market.
