Foreign Education: Loan Or Advance Planning?

If you’re planning to send your child for a world class education abroad in say, 10 years’ time, should you avail a loan at a later date, or start saving in advance? Here’s how the numbers stack up.

How Education Loans work

Education Loans work much like any other regular loans, except for the fact that they offer a moratorium period - usually for up to a year after course completion, or six months after securing a job (whichever comes earlier). Since they are unsecured in nature, their rates tend to be fairly high – currently, most foreign education loans are priced at MCLR plus one per cent or so, which adds up to roughly 7.5 per cent  as on date. Some banks offer concessions ranging from 0.5 per cent  to 0.75 per cent  for girl students.

It’s important to note that the actual interest rate for an education loan will fluctuate throughout the life of the repayment period, since rates will be reset every year based on the MCLR prevailing at that time. This is good news for those whose repayment will commence during a falling interest rate scenario. It’s difficult to predict interest rates so far down the line.

Section 80E Benefits

As a nation of ‘tax saving hungry’ people, the hefty tax deductions that education loans have to offer goes on to greatly enhance their attractiveness in our eyes. At present, the complete interest portion of the loan EMI paid in a given fiscal is deductible from your income, but only for a repayment period not exceeding eight years. 

Assuming a loan amount of Rs one crore, an interest rate of 7.5 per cent (on average), and an eight-year repayment period, this could add up to sizeable tax saving of nearly Rs 10 Lakh, assuming you’re in the highest marginal tax bracket. 

In this scenario, your EMI would work out to Rs 1.38 lakh per month – total out of pocket outgo of Rs 1.33 crore. After accounting for the potential tax saving (assuming that there’s no drastic change in tax norms related to Section 80E by then), your total out of pocket outgo, including interest expenses, would work out to roughly 1.23 crore.

Saving in advance vs. Borrowing

There’s another option at hand – saving in advance, if your cash flows permit doing so. Saving approximately Rs 43,500 per month in an aggressive equity fund via SIP’s can help you accumulate the same amount (Rs one crore) in 10 years’ time, assuming a reasonable 12 per cent CAGR. In this case, you’ll be saving Rs 52 lakh  from your pocket, and your money will get multiplied by approximately 1.92 times. Saving this amount in an ELSS (Equity Linked Saving Scheme) can help you save more money by allowing for deductions under Section 80C as well.

Even without accounting for potential tax deductions from ELSS investments, the ‘saving in advance’ scenario results in a net saving of close to Rs 70 lakhs!

End Note: Don’t let the tax deduction benefits of Section 80E lull you into a false sense of complacency with respect to planning in advance for your child’s education. Saving in advance will not just save you a large sum of money; it’ll also ensure that you aren’t saddled with the pressure of repaying loans at a time that you should be aggressively building out your nest egg. If Rs 43,500 seems steep, don’t fret – start with what you can and out in an auto-step up plan in place. You’ll be surprised with what you can achieve with a disciplined annual step up in the quantum of your goal based savings.