Sunday, May 29, 2011

Education Loan

Education loan helps cut tax

Don't dip into your retirement savings to pay for your children's higher studies. Instead, take an education loan because the tax benefits bring down the effective cost of borrowing.

  While everybody wants their child to have a good education, Indian parents are especially intent on achieving this goad. So focused are they that they are willing to scrounge on basic indulgences to save for their kids' college fees. The problem is that in their efforts to fulfill the needs of the child, they sometimes sacrifice more that they should. They dip into their retirement funds to pay for the education. This is a dangerous strategy because it leaves them financially vulnerable to their sunset years.
We all know that the cost of higher education is raising at a fast pace. Unless you foresaw this trend 10-12 years ago and started investing aggressively for this goal, your savings alone might not be enough to fund your child's higher education. Instead of withdrawing from your Provident Fund or PPF, it's better to bridge the gap with an education loan. It is not only tax-efficient, but helps inculcate financial discipline in the child by making him responsible in his early working years.

It may be argued that taking a loan in these times of high interest rates is not a prudent strategy. You will be paying 12-14% on the loan, while your investments earn only 8-8.5%. However, keep in mind that any loan taken to pay for the education of your child is eligible for income tax benefits. Under section 80E, the entire interest paid on the loan is eligible for tax deduction. The savings in tax can drastically bring down the effective cost of the loan.

The higher the taxable income of the individual, the bigger tax benefits. See Table:
Loan Amt: Rs 500000; Interest Rate: 12%; Term: 8 years; EMI: Rs 8,126

Check Education Loan Calculator for more figures

For someone in the highest tax bracket, a loan taken at 12% p.a effectively costs 8.71% a year. This is very cheap considering today's regime of high in today's regime of high interest rates, wherein personal loans are available at 18-20%. Also, unlike a home loan, where the tax deduction for self-occupied houses is limited to Rs 1,50,000 in a year, there is no limit to the tax deduction on an education loan. However, keep in mind that most lenders don't give education loans for more than Rs 10 lakh, so a limit is set by default.

An education loan will also help in making your child financially responsible in his early working years. Education loans usually come with an EMI holiday and the repayment can be deferred for up to 1-2 year till the student has taken a job. In the initial years, when the financial responsibilities are few, young people tend to be extravagant. However, if you shift the burden of repaying the loan to your child, he will be more careful with his money and is less likely to blow it up at a discotheque or on gadgets and gizmos. The loan EMI will act as a deterrent and force him to be frugal in his spending.

Eligibility for tax deduction:
You can avail of income tax deduction for the interest under Section 80E only if the loan has been taken for yourself, spouse or children. The interest paid on loans taken for siblings or other relatives is not eligible for income tax deduction.

Collateral requirements:
If the loan is more than Rs 3-4 lakhs, the lender may insist on a collateral as security. This could be immovable property, National Savings Certificates, Fixed Deposits, bonds and endowment insurance policies. This is a necessary formality and one should not shy away from providing the collateral.

Specified lenders:
If you are seeking tax deduction, the loan should be from a bank or financial institution notified for the purpose. No tax deduction is available if the loan has been taken from a private source or an overseas lender. Some charitable institutions are also included in the approved list.

Courses covered:
Full-time graduate or post-graduate courses in engineering, medicine, management, applied sciences, vocational studies after senior secondary or its equivalent are eligible for education loans. This can be from any school, board or university recognised by the Central or state government.

Interest deductible for eight years:
Unlike a home loan, the interest deduction is available for a maximum of eight years. If you take an education loan in 2011 and start repaying it in 2013, the interest deduction will not be allowed after 2021.

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