How to Make Sense of the Indian Economy: Education Loan Interest Rate Primer

Good education is the ultimate leveler and the most significant driver of wealth and prosperity. Data from the National Family Health Survey (NFHS) makes a solid case after surveying more than 600,000 Indian households in 2015-16.

How to Make Sense of the Indian Economy: Education Loan Interest Rate Primer
Source: NHFS Unit-Level Data

As evident, there is a clear correlation between education and prosperity. People and institutions know that. Hence it shouldn’t come as a surprise that good education is a costly business. Many families hence, especially poor and middle-income households depend on banks to ensure their children can make their economic leap. Tuition fees, especially for professional colleges, can range in multiples of lakhs, making access to credit essential. Even though our banking system has lately not done any favours to this sector (considering the depressed monthly growth as shown in the below chart), education’s aspirational value and importance cannot be understated.

Education Loan Monthly Growth
Source: RBI Data

 

Thereby, I will now attempt to do a deep dive into how Education Loans work and how you as a consumer can benefit from them.

 

What?

 

The Education Loan is a product which can help you fund your higher education in India or abroad. They form a part of Priority sector lending targets as set by the RBI. They can be used to finance a wide variety of courses, be it graduation, post-graduation, vocational courses, and other certificate courses. It is a loan Secured over guarantees and for larger amounts an asset of the Parent/Guardian (who acts as a co-borrower).

 

How?

 

Maximum loan amount sanctioned depends on the type of educational institution the applicant is headed to. For premier institutions banks can sanction amounts up to INR40L. Banks often ask for co-applicants to fund part of their requirement through a down-payment (or “margin money” in banker parlance). There are specialist products available for studying abroad as well e.g. from financial institutions like HDFC Credila.

 

The loan is to be repaid as Equated Monthly Installments (EMIs) over the duration of up to 15 years (“loan period”). An EMI plan essentially spreads the total principal & interest due equally over the loan period and is chargeable on a monthly-basis.

How to Make Sense of the Indian Economy: Education Loan Interest Rate Primer 

What Interest Rate?

 

Like car and home loans, the EMI is calculated based on the principal to be borrowed, the applicable interest rate, and the loan period.

 

The applicable interest rate is set by the bank and is usually “Floating” in nature for Education Loans i.e. it changes throughout the loan period subject to RBI rates.

 

This interest rate depends on individual factors:

 

  1. The institution you’re headed towards to study
  2. College fees & other expenses
  3. Credit score/history of Guarantor and/or a tangible collateral as security (e.g. house, plot of land, a fixed deposit etc.)
  4. Past academic record

 

Macro factors primarily comprise the benchmark interest rate in the country which in turn influences all consumer facing interest rates, as explainer earlier

 

You can check an online loan marketplace to get a sense of the applicable interest rates. They are usually expressed on an annualized basis.

 

The floating rate is usually structured as:

 

1-year MCLR + Spread

 

In layman terms, MCLR or “Marginal Cost of Funds Based Lending Rateis the minimum allowed interest rate below which a scheduled commercial bank or NBFC is not allowed to lend. It is fixed by the Reserve Bank of India (RBI) and is closely tracking the short-term interest rates set by the Central Bank.

 

Floating interest rate, as the name suggests is not constant, and is “Floating” during the loan period depending on RBI’s monetary policy actions. They ensure borrowers can benefit from any rate reduction exercises by the RBI after they have already taken the loan. The additional Spread will include the margin that the lending bank would make.

 

Other Charges?

 

There is usually no processing fee, no prepayment charges, or pre-closure charges for Education Loans. Loans for studying abroad are structured differently and may have certain processing charges etc.  

 

Things to Watch

 

  1. Shorter is the loan period, lower would be the interest rate applicable
  2. A higher down-payment will result in a lower interest rate
  3. Do check when the loan repayment schedule kicks-in. Usually it starts 6-12 months after completion of one’s degree. Interest however would accrue during the moratorium period (time during the loan term when the borrower is not required to make any repayment), thereby it is better to start repaying as soon as one can
  4. Banks may push the co-borrower/parent to take a Life insurance cover in addition to the Education Loan. This is usually not mandatory but is often used as criteria by banks to approve/reject an application.  There have also been instances where the bank has wrongly pushed its own insurance products on customers taking Education Loans
  5. Interest being paid is allowable as tax deduction from total income under Section 80E. There is no tax benefit on the principal part of the EMI

 

Next, we will discuss through a series of two article focused on gold, both as an investment and savings asset class.  

 

This will be a recurring column published every Friday under the title: “How to Make Sense of the Indian Economy”.

 

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