What you MUST KNOW about education loans

It cuts both ways -- you can build your credit score and get tax benefit, but defaulting will make life difficult, says Sarbajeet K Sen.

With the cost of education rising, many students are likely to start their first jobs with an equated monthly instalment.

A two-year programme at a leading Indian management institute can cost above Rs 25 lakh. A similar course at a good foreign university today costs Rs 1 crore or more.

Such high costs leave the student, or her family, with no option but to avail of an education loan.

Lenders are willing to fund only select courses and may ask for a guarantor and even collateral to cover the amount.

If you are one of those who have been able to convince a lender to extend a loan to fund your study, your financial journey has just begun. And you will be home only after paying the last rupee.

But such a start has its advantages, too.

Helps build credit history

The credit score ranges from 300 to 900.

It takes 18 to 36 months to build a good score.

A number in excess of 750 is considered good.

When you repay your education loan on time, your score improves, and so does your credit profile.

On the flip side, if you default on your repayments, your credit score goes for a toss, making life difficult.

"If a student defaults on his education loan, it will affect his credit score and make it difficult for her to get other loans and credit cards," says Rachit Chawla, founder and CEO, Finway.

Co-borrowers also affected

When the loan amount is large, lenders ask for co-borrowers.

In case of a default, the co-borrower's credit history also gets affected.

"Co-borrowers have equal liability and will get into difficulties. In the case of guarantors, lenders will pursue them for payments," says Chawla.

If property has been pledged as collateral, it may be attached by the lender to recover its dues.

Enjoy tax benefits

Section 80E of the Income Tax Act specifies that interest paid on an education loan is eligible for deduction from one's income.

This deduction is allowed for eight years from the year in which the student starts repaying the loan or for the tenure of the loan, whichever is lower.

One needs to obtain a certificate from the lender, specifying the interest repayment clearly, as the EMI consists of principal repayment also.

Parents who are co-borrowers can also avail of tax benefits.

No tax benefit is available on principal repayment.

Makes you disciplined

If you repay your education loan EMIs on time, it will teach you a significant financial lesson that will come in handy when you avail of large loans later.

A youngster who starts earning a salary and paying EMIs from day one learns to manage his cash flows.

Should you pre-pay?

The answer to this question depends on multiple factors.

The common-sense approach says if you have excess money, you should consider some pre-payment.

"It is definitely wise to pre-pay an education loan to counter the prolonged debt burden. The interest paid will also be significantly lower if you pre-pay," says Aditya Kumar, founder and CEO, Qbera.com.

However, lenders often levy a penalty for pre-payment of education loans, especially in the first six to 12 months of the date from which the repayment begins. This must be accounted for if you plan to pre-pay.

Sometimes students opt for long tenures.

Education loans are typically available for as long as 15 years. However, the tax benefit on interest repayment is available for only eight years.

Sometimes, fast career growth leaves a lot of surplus in the hands of the borrower.

In such circumstances, it makes sense to repay the education loan towards the end of the eighth year since tax benefit will not be available thereafter.

Finally, do not forget to obtain the no-dues certificate from the lender once you have prepaid your entire dues.