Interest part of education loan repayment is tax deductible

Live Mint ;Wed, Oct 02 2013. 06 16 PM IST

However, the principal repayment will not qualify for tax benefit.

To pursue higher studies, I took an education loan of Rs.7 lakh. Now that I am employed, I pay around Rs.15,500 as equated monthly instalment (EMI) including interest. Am I eligible for any tax benefit?

—R.D. Mehta

The interest paid on an education loan taken to pursue higher education qualifies for tax benefit/deduction. However, the principal repayment will not qualify for tax benefit. Accordingly, out of the total monthly EMI of Rs.15,500, you can avail deduction only towards interest portion of the EMI. The deduction can be availed for eight financial years (FYs) starting from the FY in which you have started paying interest.

Further, the tax deduction is allowed only if the education loan has been availed from any banking company or notified financial institution or any approved charitable institution. Higher education includes any course of study pursued after finishing senior secondary examination or its equivalent from any recognized school, board or university or any other authorized authority.

Should you prepay your student loan?

BL : B Venkatesh :Oct 3, 2013:  

Individuals are increasingly taking a student loan to fund their higher education.

If you are one of them, you have a choice once you become gainfully employed — to either prepay your student loan or invest that additional money to create wealth to meet future life goals.

In this article, we discuss why your choice is primarily a function of your emotional well-being, and not just driven by factors such as tax benefits, prepayment penalty and interest savings.

Asset-loan linkage

For most of you, an education/student loan is your first borrowing, and certainly not the last. During your working life, you would borrow to buy a house or replace your car. There is a significant difference between your student loan and the others.

Your student loan helps in improving your human capital, which is the present value of all your future income during your working life. The problem is that many of you take up jobs in sectors that may be unrelated to the specialisation that you mastered in your business school. You may have, for instance, specialised in finance but would have started your career in a technology company. You may eventually benefit from your finance specialisation. But the immediate linkage between the borrowing cost and the creation of the asset (human capital) may not be strong.

This is quite different from a home or car loan that you take during your working life. With such loans, you typically acquire physical assets, which could appreciate or depreciate in value over time. Importantly, the borrowing leads to realising immediate tangible benefits. And that is the reason why the decision whether to prepay your student loan should be treated differently from prepaying other loans.

Given the above factors, systematically prepaying your student loan leads to better emotional well-being and helps you in crafting a disciplined path to creating wealth. How?

Emotional well-being

Suppose you start your career with post-tax monthly salary of Rs 75,000 with a monthly student-loan payment of Rs 20,000. Further, suppose you choose to repay Rs 30,000 every month including prepayment of Rs 10,000.

Having managed your living expenses without Rs 30,000 every month, you can continue doing so even after you repay the loan! You can invest this amount in mutual funds thereafter to create wealth for future needs. Of course, you could alternatively repay Rs 20,000 and independently set up a systematic investment of Rs 10,000 every month. So, why is prepayment better?

The reason has to do with your emotional well-being. In the initial years of your career, you are busy gaining a foothold in your profession. A student loan may be a cause for concern, especially, if you work in an industry whose fortunes are cyclical. Why? Worst-case scenario, you could lose your job because of industry downturn and your investment portfolio could also lose value because of market decline! What will you do?

Now, you may ask about the possibility of both events happening at the same time. The likelihood of 2008 sub-prime-like crisis happening in the near-future may be small, but the anxiety that it could happen can have a debilitating effect on your emotional well-being. And remember, your emotional strength is important to take sound financial and professional decisions.

Conclusion

The emotional stress of unpaid student loan in the initial years of your career can be overwhelming. The penalty for prepaying the loan, if any, and the personal-tax benefit on regular interest payments, assuming tax laws remain the same, cannot be meaningfully compared to the emotional stress of carrying the loan. But before you decide to prepay your student loan, create adequate emergency fund to meet situations such as temporary loss of income and medical emergencies.

(The author is the founder of Navera Consulting, a firm that offers wealth-mapping and investor-learning solutions. Feedback may be sent to knowledge@thehindu.co.in)

BLURB: Because of the characteristic of the asset that you create from your student loan, your prepayment decision is based more on your emotional well-being than on the interest cost you save by prepaying.

(This article was published on October 3, 2013)

Checklist for education loans

For loans over Rs 4 lakh and up to Rs 7.5 lakh, a suitable third party guarantee is all that is required.

BL : Maulik Tewari ;June 1, 2013

Interest rates vary across banks, so survey many institutions before you zero in on one.

It’s that time of the year when students gear up for admissions to colleges and universities. Getting a seat at an institution of your choice may be the first priority, but being able to fund that education is equally important. Education loans are an option you canconsider.

WHAT’S ON OFFER

Banks offer loans for many graduate, postgraduate and other professional courses run by recognised institutions in India and abroad. Most banks lend a maximum of Rs 10 lakh and Rs 20 lakh for studies in India and abroad, respectively.

Some offer larger amounts too. For example, Indian Overseas Bank gives Rs 15 lakh for education inside the country and Rs 25 lakh for foreign education. State Bank of India can loan up to Rs 30 lakh for education abroad.

Since interest rates vary across banks, survey around to get the best deal possible. At present, the interest rates are in the range of about 11 per cent to 14 per cent. But remember that these loans are offered on a floating rate basis. So you need to be prepared for the risk of higher interest rates in future. But, you also stand to benefit if the base rate is revised downwards.

There are few ways in which your interest burden could be lower. If you have happen to make it to one of the country’s premier institutes including the IITs and the IIMs, then do check whether banks offer any loan scheme for students of these institutions.

The advantages could be many – relatively lower interest costs, higher loan amount and easier or no collateral requirements. SBI’s ‘Scholar Loans’ and Bank of India’s ‘Star Vidya Loan’ are two such schemes. Also, some banks offer a 0.5 per cent to 1 per cent concession in interest rates to girl students.

Those belonging to an economically weaker section i.e. those with an annual family income (from all sources) of up to Rs 4.5 lakh – can also hope for some relief. Such students can avail full interest subsidy during the moratorium (holiday) period.

However, they will have to bear the interest costs post this period. The scheme is applicable only for studies in India.

MARGIN MONEY

If you are borrowing up to Rs 4 lakh, you do not have to bother about margin money. But, if your loan exceeds this amount then you have to satisfy the bank that you are capable of meeting a part of the cost yourself. Generally, margin for loans for studies in India and abroad is 5 per cent and 15 per cent, respectively.

The good thing is that scholarship money, if any, will be considered a part of the margin money.

For loans over Rs 4 lakh and up to Rs 7.5 lakh, a suitable third party guarantee is all that is required. But you need to arrange for suitable collateral if your loan amount exceeds Rs 7.5 lakh. This could be an immovable property, fixed deposit, NSC or an LIC policy, among other things. A student taking a foreign education loan has yet another thing to take note of. A loan is sanctioned by a bank in rupees. At the time of disbursement, the bank will dispatch an equivalent amount in foreign currency (based on the existing exchange rate). If the rupee is relatively weaker then, the student will receive a lower amount. So, a student has to be prepared to bear this foreign exchange risk.

REPAYMENT

For education loans, banks allow a moratorium (holiday) – the period during which you do not have to start repaying the loan. This is taken as the course period plus one year or six months after getting a job, whichever is earlier. It is after this period that the EMIs begin.

It, however, makes sense to start paying/servicing the interest during the holiday period itself, if possible. If you do so, your EMIs will be lower. If you decide to service interest after the holiday period then you land up paying higher EMIs as they will be calculated based on a higher amount (principal + accumulated unpaid interest during the holiday period). Second, many banks offer a one per cent concession in interest rate during the moratorium period or even for the full tenure of the loan, if complete interest is serviced during the moratorium period.

Additionally, you can also claim the interest paid on an education loan as deduction in arriving at your taxable income. But, you must sure that the loan has been taken from an approved financial institution to be eligible to claim this benefit.

maulik.tewari@thehindu.co.in

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