Ensuring A Smooth Learning Curve

May 19 2010

With the spiralling costs of higher education, meeting the expenses on your own is a pipedream. Education loans provide an alternative.

Loan Application Process

Before you apply for an education loan, here are certain things that need to be taken care of:

  • Visit the websites of institutions from where you wish to apply for a loan
  • Compare loan products and, especially, take a look at the rate of interest on the loan, the documentation required and the loan amount
  • If the institute has a tie-up with any bank, approach the bank. If the institute does not have a tie-up, approach the bank where either you or your parents already have a banking relationship
  • If you have received an offer letter from a premier institute, check if the bank provides a differential rate of interest on the loan
  • Ensure that the EMI that you would be paying is not more than 20-30 per cent of your expected take-home salary
  • Ensure that the guarantor of your loan has a clean credit history

What The Loan Covers

An education loan typically covers the expenses listed below. However, the coverage could vary across lending institutions. So, when you approach an institution for an education loan, find out about the expenses that would be covered:

  • Fees payable to college/school/hostel
  • Examination/library/laboratory fees
  • Purchase of books/equipment/instruments/uniforms
  • Caution deposit/building fund/refundable deposit
  • Travel expenses/passage money for studies abroad
  • Purchase of computers considered necessary for completion of course
  • Insurance cover for the student
  • In some cases, cost of a two-wheeler, up to a certain limit
  • Any other expenses required to complete the course, such as study tours and project work.

In 2006, Jai Ganesh, 25, a Chennai-based marketing professional took an education loan of Rs 5.50 lakh to fund his management course after completing his mechanical engineering degree. “Since we did not have the necessary funds at that time, we decided to go for an education loan,” says Ganesh. The loan was taken from the United Bank of India’s Tiruchirappalli branch, Ganesh’s hometown. Ganesh had approached many other banks for the money, but could not make much headway, primarily because the lending institutions were hesitant in funding the course. Says Ganesh: “Though I was a meritorious student and my parents are in government service, it was difficult for me to get the education loan.” Although education loan falls under priority sector lending, yet getting it is not that easy. “One of the reasons why the penetration in India is less than 5 per cent is that the approval ratio is also very low,” says Prashant A. Bhonsle, country manager, Credila Financial Services, an HDFC venture.

Making A Headstart

Among the many goals for which parents save for a child ever since his or her birth is higher education. “Such a plan should include investments in Public Provident Fund (PPF) and index funds,” says Veer Sardesai, a Pune-based financial planner. If you have invested in equity, ideally, you should move the money to safer instruments 2-3 years before you require it. However, this is an ideal situation.

A not-so-ideal situation.

In most cases, parents, in the daily grind, are unable to plan for such huge requirement of funds. So, if you did not make specific investments to fund your child’s higher education—but did park some money even in a haphazard way—what should you do? Says Sardesai: “In that case, start tapping investments that are giving you the lowest return. Also, keep the tax consideration in mind while liquidating such investments.” So, the pecking order of liquidating investments in asset classes would be the money lying in the savings account, fixed deposits, debt funds, equities, gold and PPF.

Before liquidating your investments, keep in mind your own short and long-term goals. “If, after higher education, the next requirement is in the long term, keep your investments in equity intact and liquidate debt instruments. If other goals are in the near term, you would be better off keeping investments in debt instruments and liquidating equity,” says Gaurav Mashruwala, a Mumbai-based financial planner.

Look out.

Considering the rising cost of higher education over the years, many would find it hard to fund the entire course expenses through their own resources. For example, an MBA from any of the Indian Institutes of Management (IIMs) would cost you in excess of Rs 10 lakh. If you want to pursue a post-graduation degree overseas, it would cost you a minimum of Rs 12 lakh. If you are planning to do a course in the US, the cost would be even higher. So, what to do if funds from your own resources aren’t enough? “Look at grants and scholarships. A lot of merit-based scholarships are available, both for courses in India and overseas,” Harsh Roongta, CEO, ApnaPaisa. What if you are unable to get a scholarship to either fully or partly fund the course? “If you still fall short of funds, education loans are a good option,” says Roongta.

Education Loans

If you have the necessary funds to fund the entire course, does it still make sense for you to partly fund the course and let your child take an education loan for the balance amount?
Even though you can fund the entire expenses of a course, it makes sense for you to give education loans a look. This is especially true if you fall in the highest income tax bracket.

Should you take a loan?

“There have been instances where parents have taken a loan even when they can fully fund the course: it’s a good way of ensuring that the child is made responsible at an early stage,” says Alok Bansal, CEO, Alethia Education Services. Roongta adds: “If you fall in the highest income tax bracket, you may consider giving education loans a look, even though you are able to fund the total cost of education.” The reason being that the interest paid on education loans is tax deductible without any limit. Bhonsle gives more reasons: It boosts the self-esteem of a student because an education loan gives him an opportunity to start taking his own financial responsibilities. A good repayment track record on the very first loan can get better rates for other loans (home, personal, car, credit cards) later.
There is a contrarian view as well. “If parents can fund the entire cost of education, they should,” says Mashruwala. Says Sardesai: “If you are able to fund the entire cost of education through your own resources, it does not make sense to take an education loan as it sets the child back in the wealth creation process. Financial discipline cannot be inculcated in a child in the last few years of his education years. It needs to be done from a much younger age.” If you can fully fund a project, never take a loan. “This is a general principle and it applies to education loans as well,” says Roongta.

The starting point.

For most people, a loan may be the only option to fund their child’s higher education. So, how do you start? The first step would be choosing a course. A course from a leading institute has many advantages. In most cases, banks have a readymade list of courses/institutes that they plan to fund through an education loan. Courses conducted by the IIMs, Indian Institutes of Technology (IITs), Indian Institute of Science (IISc), Xavier Labour Relations Institute (XLRI) are a few examples. In such cases, the loan approval process is typically faster. Also, lending institutes usually provide a differential rate of interest if the course is from a premier institute. “In case of Indian School of Business, we have given loans at 9.75 per cent,” says Bhonsle.
He adds: “It may be a good idea to apply to banks/lenders at the earliest and find out the loan eligibility so that there are no surprises during the time of admission and fee submission.” These days, institutes also have a tie-up with lending institutions. So, once you get an offer letter, approaching those lending institutions would be a good starting point. “The other option would be to approach the bank where either you or your parents already have a banking relationship,” says Bansal.

Do your homework.

Before approaching a lending institution, do the necessary homework. Visit their website, look at the features of their education loan product, such as the minimum-maximum loan amount, the rate of interest, margin money, the repayment period, documentation required, collateral and guarantor requirement, and so on. Check if there any late payment fees or pre-payment penalty.

The product.

Education loan is a fairly straight-jacketed product. The maximum loan that you will typically get for studies in India is Rs 10 lakh, and for overseas studies, the limit is Rs 20 lakh. For a loan amount of up to Rs 4 lakh, typically, the lending institution won’t seek any security. For loan amounts between Rs 4 lakh and Rs 7.50 lakh, they ask for collateral security in form of a suitable third-party guarantee. In exceptional cases, the bank may, at its discretion, waive the third-party guarantee if it is satisfied with the net-worth of the parents who would be executing the documents as joint borrower.
For a loan amount of more than Rs 7.50 lakh, the lending institution will typically ask for tangible security of suitable value along with the assignment of future income of the student for the payment of instalments. For a loan amount up to Rs 4 lakh, the lending institution typically doesn’t ask for any margin. For more than Rs 4 lakh, it will ask for a 5 per cent margin for studies in India, and 15 per cent for abroad. Also, the loan is typically repayable in 5-7 years. The rate of interest on the loan currently varies between 9.50 per cent and 15.75 per cent. But it still makes sense for you to look for rates across institutions. The reason being if the loan amount is huge, even a 25 basis point difference matters. Further, a concession on the rate of interest is provided to girl students, particularly the education loan product offered by public sector banks.
While there's no thumb rule as to how much you should borrow, ensure that what your child pays on the education loan is not more than 20-30 per cent of his expected take-home.
The entry of private players in this space has resulted in modifications in education loan as a product. For example, in case of the education loan product of Credila Financial Services, the minimum loan amount is Rs 1 lakh and the maximum is Rs 30 lakh. “If the student is bright and the course that he is planning to do is also good and from a good institute, there is no issue of the loan amount,” says Bhonsle.
The rate of interest on the loan by Credila Financial Services varies between 9.75 per cent and 12.50 per cent. “It, however, depends on a lot of factors,” says Bhonsle. Some of these are the institute, the quality of course, the university or college, the academic track record of the student, chances of employability and family background. There is also a modification with regard to collateral requirements. “In our case, if the student is good and even if the property value is less than the loan amount required, we can give the loan,” says Bhonsle. The repayment period can go up to eight years. “We can go higher as well,” he adds. Credila Financial Services also finances up to 100 per cent of the loan amount needed.

Time required.

If you have all the documents in place, how much time would it take to receive the loan sanction letter? “It’s a very big IF that all the documents will be in place. Logically, it takes time. On an optimistic basis, it takes around 30-35 working days to get the loan sanction letter and, if everything is in order, another 15-30 days to get the disbursement. The process would roughly take about two months,” says Roongta. Problems arise with overseas courses, especially if the institute is not well known. Things are a little better with private players. “If the documentation is authentic and complete, Credila Financial Services takes less than seven days to issue the sanction letter,” claims Bhonsle.

How much should you borrow?

Ganesh has completed his MBA and has been regularly servicing the loans for the past 20 months. “One-third of my salary goes towards servicing the loan. I am in a comfortable position, but if there is a health emergency where huge funds are required, there could be a problem,” he says. There is no thumb rule, ensure that what your child pays on the education loan is not more than 20-30 per cent of his expected take home salary.

Second lender?

What should you do if an institution rejects your education loan application? If it was because the institution had problems with the proposed course, it makes sense for you to apply to another lending institution. However, if the loan was rejected due to problems with the credit history of the guarantor, chances are that your loan application would be rejected across lenders.

The repayment.

The repayment typically starts one year after completion of the course or six months after securing a job, whichever is earlier. Typically, the repayment period is 5-7 years. If you get a high-paying job after completing the course, it makes sense for you to repay the loan at the earliest. What are the documents that you need to collect after you have paid the loan in full? “It is similar to other loans where the lender may issue a closing statement after due diligence and account reconciliation,” says Bhonsle. “Once you have repaid the loan in full, you should take a no-dues certificate from the lending institution. Also, take back any documents that you had provided the lending institution as collateral,” says Roongta. If you had pledged any of your investments, make sure they are reassigned in your name after the loan is paid in full.
An education loan can go a long way in fulfilling your dreams, but before you sign on the dotted line, make sure you understand the product so that it acts as an enabler rather an obstacle.