This is a guest post by Ramesh Patil who runs a website offering information about IFSC and MICR codes.
Education is perhaps an individual’s most precious resource today. In fact, nowadays education is at times equated to an investment, which in all truth it is. However, if we purely take perspective at education as an investment point of view, the price of education at times requires you to take loans from banks or other sources, which require you to pay off the debt after your “investment" or education starts bearing fruits. As easy as loan grant sounds, the more difficult it can be to pay off. However with careful planning and timely repayments, one prevents himself/herself from coming under what is called “debt pressure".
Should you prepay your education loan?
Education loan is basically an amount bank has paid on your behalf. So with every passing day, this loan accrues some interest. You pay this loan in EMIs because you cannot pay off all the loan amount i.e. principal and interest at one go. So one way to limit the interest that you will pay on education loan is to pay it off as early as possible. But education loan also helps you save Tax under section 80E. We have created an excel sheet that will help you decide when to pay off the education loan.
If you cannot prepay the loan, follow these tips while paying EMI on the education loans in India:
1) Start Early:
Don’t wait till your graduation, to start planning on the repayment. Have a repayment model ready as soon as the first phase of education (generally the first semester) is over. This will enable you start saving early and gradually ease off the pressure of the interest which piles up and by the time of moratorium period ends, you would have already started with the repayment. If you have some savings already in your account when you graduate, you could start paying the loan even before the moratorium period begins. Do keep in mind that your loan is accruing interest even during the moratorium period.
2) Set a comfortable EMI. Don’t be over ambitious:
Setting a lower EMI for a longer duration might just be a better option than ambitiously trying to pay off the loan early. Paying off the loan early is always the better option, but not by compromising on other important needs like lifestyle expenses or training costs for furthering professional skills.
3) Prefer a loan from Government Bank (or PSU Banks):
PSU banks typically offer loans at lower rates than private banks. They are also more lenient when it comes to prepayment of the loan. E.g. Andhra bank does not levy any charges for partial or full repayment while HDFC banks charges penalty proportionate to the amount of loan outstanding.
4) Speed up the repayment using the tax benefits:
Education loans provide you tax benefits and the amount that you save can actually be used quite significantly for paying off your debt faster. One way to do this is calculate the amount that you save exclusively from taxes and deposit it biweekly along with the ongoing EMI. This might seem insignificant in the short run but saves you almost 3-4 months during the final payment which results into about 25-30% lesser interest being paid.
5) Accelerate your payments by adding very small amounts:
This is the best of all strategies. Even if you add ~100 extra every month for just 2 years consistently, you can save up to ~20,000 in interest and you will end up finishing an 110 month loan in 106-107 months saving 4 months.
6) Pay off some part using bonus:
Every year, you will get bonus at the end of the year. You can use this bonus to pay off part of your loan.
The key is to plan and stick to the model that you have decided. Once you are earning in lakhs, a few thousands in the long run won’t matter.
Calculate when to pay off your education loan
Once you take the loan, you have to start planning how you would pay it off. Should you wait for the entire loan tenure or pay it off before that? How much money will you save and how much tax benefit will you forgo? And as such how much tax would you save through this loan?
Check this calculator for answers to all these questions.
1) A1-11 are input cells. Enter the details of the loan you have taken here.
2) Once you enter the data, you will see that excel will calculate the formulae and fill the columns E to L with data.
3) Column G indicates the tax you would save every month if you keep paying EMIs.
4) Column H indicates the total value of the entire tax benefit you would forgo if you pay off the loan in corresponding month. This is basically the current value of all the tax savings you would have got in the future.
5) Column I is the prepayment penalty for paying off the loan.
6) Column L is money saved by paying off the loan early.
7) There are two graphs that show money saved if you pay early. The first graph shows two lines rad and blue. Actual money saved is the difference between these two lines.
8) The graphs clearly show that you would get maximum benefit by paying off the loan as early as possible. i.e. the tax benefit forgone and prepayment penalty by paying off the loan does not exceed the interest saved by paying off the loan.
Don’t forget to share your feedback in the comments below.
This post was written by Ramesh who runs a website offering information about IFSC and MICR codes.
If you have any questions, you can contact him at @RameshPatil1980