Obtaining a good education is a crucial foundation for success and ensuring a secure financial future. However, the price tag of higher education has been gradually climbing, making it difficult for most students and families to meet tuition, housing, and other expenses. To support this bill, students often utilize something called education loans, which help them gather the required amount of money to continue their studies without placing a significant financial burden on their pockets.
Education loans are a preferable option for financing higher studies, but it is essential to understand the terms and conditions associated with them, including the interest rate and payment plan. This led many students and parents to wonder whether education loans come along with interest rates, and how they affect the total repayment amount. In the article, you will learn all about the interest rates on education loans, including the methods of calculation, the grace period, tax benefits, and the aspects to consider while comparing lenders. Armed with this knowledge, borrowers can make informed financial decisions and select the best loan option for their specific circumstances.
Education Loans: Do They Have Interest?
I mean all loans, even education loans, have an interest element. Interest is the percentage of the principal amount that the lender charges the borrower as the cost of borrowing money. This rate is usually expressed on an annual basis and has a tremendous impact on the amount that needs to be repaid.
For instance, if a student takes a loan of INR 10 lakhs with an interest rate of 12% per annum, then they have to pay INR 1.2 lakhs as interest every year, in addition to repaying the principal amount. It is essential to understand how this interest is calculated and applied to manage loan repayments.
Types of Interest Rates on Education Loans
Education loans are available with either fixed or floating interest rates.
- Fixed Interest Rate: This rate remains the same over the loan period. The benefit of a fixed interest rate is that it provides borrowers with predictability regarding their EMIs (Equated Monthly Instalments), allowing them to plan their finances accordingly. On the other hand, when interest rates in the market decrease, a fixed-rate loan borrower does not enjoy the decreased rates.
- Floating Interest Rate: This interest rate fluctuates in response to dynamic market conditions or economic factors, as it is tied to a benchmark rate such as the Repo Rate or Marginal Cost of Lending Rate (MCLR). Although floating rates may fluctuate more than fixed rates, they can also increase, resulting in a higher total repayment amount over time.
Interest on Education Loans: Methods of Calculation
There are two primary methods lenders use to calculate interest on education loans: simple interest and compound interest.
1. Simple Interest
With simple interest, interest is calculated just on the principal loan amount. Simple interest formula:
Simple Interest = Principal × Interest Rate × Period
For instance, if a student avails a loan of INR 1 lakh for 3 years at the rate of interest of 10%, the calculation will be as follows:
- Year 1 Interest = INR 1,00,000 x 10% x 1 = INR 10,000
- Interest for Year 2 — INR 1,00,000 x 10% x 1 = INR 10,000
- Year 3: Interest: INR 1,00,000 x 10% x 1 = INR 10,000
Interest payable per annum = INR 10,000.
2. Compound Interest
In contrast, compound interest is the more complex and potentially rewarding type as it is calculated on the initial principal, which also includes all of the accumulated interest from previous periods. Here’s the formula for compound interest:
Compound Interest = P x (1 + Interest Rate/Compounding Frequency) ^ (Compounding Frequency x Tenure)
Suppose a student takes an education loan of INR 10 lakhs for 2 years at the interest rate of 7% per annum (compounding annually), a calculation of it would be:
INR 10,00,000 x (1 + 0.07/1) ^ (1 x 2) = INR 10,14,049
Total interest paid throughout the tenure = INR 14,049
Compound interest leads to an increased amount paid back as compared to simple interest, which is why it is essential to find out which method a lender uses before you sign up for an education loan.
Do You Accrue Interest During the Grace Period?
Education loans differ from other types of loans in that they come with a grace period. It is designed to give borrowers time to graduate and secure employment during the period between completing the course and repaying the loan. Whether interest accrues during that time, though, ultimately depends on the lender’s terms.
Lenders generally provide two variations of grace periods:
- Grace Period with interest Payment: Under this option, the borrower is required to pay interest on the disbursed loan amount during the grace period. Principal repayment begins only after the grace period has ended.
- Grace Period Free of Interest Payment: In this case, the borrower does not have to pay interest during the grace period. However, this unpaid interest adds to the principal and increases the overall repayment burden once the grace period expires.
Are There Tax Benefits on Education Loan Interest
Tax Benefits of Education Loans: One of the benefits of an education loan is tax benefits. Section 80E of the Income Tax Act allows you to claim a tax deduction on the interest payment on education loans. Here’s how it works:
- Note that the deduction only applies to the interest portion of a loan, not the principal.
- There is no cap on the amount of interest that is deductible.
- The tax benefit is available for a fire of 8 years from the end of the computation of interest paid or when interest is paid off completely, whichever is earlier.
- Borrowers will need to obtain a certificate from the lender to be eligible for this deduction, along with a breakdown of the interest and principal components of their EMIs.
How to Compare Interest Rates from Different Lenders?
While selecting an education loan, students usually ask, “Is the rate of interest on student loans different for different lenders?” The answer is yes. The interest rates offered may vary significantly between banks, NBFCs, and other financial institutions.
Although it’s always best to lock in a loan with the lowest possible interest rate, borrowers should weigh other factors as well, including:
- Prepayment Charges: Some lenders also charge a penalty fee for prepayment.
- Processing Fees: These are institution-dependent and influence the cost of borrowing.
- Undisclosed Fees: Scrutinize the terms to look for any hidden fees.
- Loan Cap: Ensure that the lender provides sufficient funds to cover all educational costs.
Conclusion
Students aspiring to pursue higher education often find that loans can be a helpful financial instrument. Understanding interest rates, how they are calculated, grace periods, tax benefits, and comparing lenders is vital to making the right decision. By thoroughly analyzing these factors, students can select the most appropriate loan option that reduces their financial burden while also helping them pursue their desired educational goals in their chosen institutions.
