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Should You Consider Taking An Education Loan?

Financial support for higher education through student loans

Today, sending children abroad for higher education, particularly for post-graduate studies, is a common preference among parents. This kind of planning should begin well in advance, ideally at least 10 years before the intended study period, said Niraj Nanal, a Certified Financial Planner & Registered Life Planner in Pune.

Education loans have become a popular solution, but is it the right choice for everyone?

EDUCATION LOAN VS. OWN FUNDS

When it comes to funding education abroad, the most important decision you need to make is whether to take out an education loan or use your own funds. It’s essential to weigh the immediate benefits against the long-term financial implications.

Here, we will break down the decision-making process using the example of investment returns versus loan interest rates.

Let’s assume:

At first glance, you might think that using your own investments to fund your child’s education makes sense to avoid the hassle of a loan. However, there is an interesting concept to consider: opportunity cost—the potential returns you would miss out on by withdrawing funds from your investments.

Example: How Investments Can Outperform Loan Repayment

Even though the loan interest rate is 8%, if your investments are generating a 12% return, this creates a scenario where the returns from your investments could actually outpace the cost of the loan. Let’s break this down:

Let’s break this down with an example

If we assume that you need to borrow Rs. 10, 00,000 for your child’s education at an interest rate of 8% p.a. & also assume that you keep Rs. 10, 00,000 invested in your portfolio, which will grow at 12% p.a. The interest/ return amount will be as following:

Educational Loan Investment

So, by keeping your ₹10, 00,000 invested, you’re effectively earning ₹40,000 more than what you’re paying in interest.

Thus, your investments are working harder for you than the cost of borrowing.

This should be considered before taking a loan, and you should have a provision in place to ensure that the loan repayment does not increase your financial burden.

Tax Benefits under section 80E

One significant advantage of taking education loan is the tax benefit under Section 80E of the Income Tax Act. This section allows you to claim a deduction on the interest paid on the education loan for higher education whether in India or abroad.

This deduction is allowed only on the interest amount paid and is available for a maximum of 8 years or until the interest is fully paid, whichever is earlier.

The loan should be taken for higher studies of self, spouse or children or for student for whom the individual is legal guardian.

This can significantly reduce your taxable income, resulting in lower tax liability. It’s essential to consider this tax relief when evaluating the total cost of borrowing and comparing it with other funding options.

Further, the deduction can be claimed only by those who pay taxes under the Old Tax Regime. 

While we advocate that taking an education loan makes financial sense in many cases, this does not mean that, as a parent, you should neglect saving for your child’s financial needs. Rather, it should be viewed as a tactical adjustment to be made based on what makes the most financial sense in your particular situation.

How To Evaluate Whether an Education Loan is the Right Choice?

1. What’s the cost of the education?

Evaluate the total cost of education, including tuition and living expenses, and compare it with your available savings and investments.

2. What is the repayment structure of the loan?

Assess the loan’s moratorium period and your ability to comfortably manage repayments based on your future income.

3. How will the loan impact your future financial plans?

Consider how the loan repayment might affect your long-term financial goals, such as retirement or purchasing a home.

4. Do you have the financial discipline to manage the loan?

Ensure you have the ability to manage debt responsibly without stress or sacrificing other financial priorities.

Conclusion

Before committing to an education loan, it’s vital to evaluate your financial situation carefully. A Certified Financial Planner can help assess the overall cost, repayment structure, and impact on your future financial goals. While loans can offer flexibility and tax benefits, balancing investment returns and loan interest rates, along with maintaining financial discipline, will ensure you make a well-informed decision that aligns with your financial strategy.

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– Shrees Haralkar, Associate FP.

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