Twenties can be a little overwhelming with bills to pay and rent to take care of with a not-so-whopping salary at the beginning of your career. On top of that, if you have an education loan that’s awaiting paying off, you must be seriously weighing your priorities. Your education loan is probably the first big borrowing in your life and unlike a house loan or car loan, this one is not an investment in a physical asset which is appreciating or depreciating with time. It is an investment in human capital and the borrowing cost may not be on par with the asset creation. “The pay check you had estimated at the time of borrowing the loan might have been different from what you earn at present. Although you might eventually benefit from the education, the present output might not match the cost. However, taking a loan holiday from the bank will disrupt your repayment plan, and remaining on a steady repayment plan may reduce your ability to create long-term wealth,” says Adhil Shetty, CEO, BankBazaar.
So how do you manage your finances?
Should you pre-pay?
Pre-payment refers to repayment of a loan before the stipulated period of time. This involves paying extra towards the monthly EMI, which reduces the interest to be paid to the bank, thus cutting down your long-term dues. Pre-payment can be done partially or entirely.
Your education loan attracts an interest rate of 11 to 13% and if the EMI amounts up to 50% of your current monthly salary, you should definitely consider paying off the loan at the earliest. “If your education loan has a floating rate of interest, your EMIs could go up unpredictably disrupting your monthly allocations for paying off debts and investment. Once you are freed from the burden of paying EMIs for the education loan, you can focus on creating wealth such as buying a home or investing in mutual funds and insurance. Although some banks charge a penalty of 2-3% on pre-payment of education loans with fixed interest rate, the borrower stands to gain from the deal in the long run,” says Shetty.
Paying off your loan early keeps your credit score steady. An outstanding balance on your education loan can reduce your chances of getting a home loan sanctioned in the future, as banks and financial institutes look at your credit scores before getting into any lending activities. They prefer that you pay off outstanding loans before acquiring a new one. Banks consider a credit score of 750 satisfactory to extend any line of lending.
On the other hand, the interest paid on education loan is eligible for deduction under Section 80E of the Income Tax Act. So you must consider the trade off in order to decide whether to pay off the loan early or continue with it.
How do you benefit from pre-payment?
Say, you have taken an education loan of Rs.1,500,000 with 12% interest rate for a tenure of five years. “Your EMI would be Rs. 33,367, considering a processing fee of 2%. The amount payable would be Rs. 2,032,000 at the end of five years. If you start pre-paying your EMI after two years from the time of taking the loan by paying an extra EMI every six months, you would finish paying off your loan within three years of taking the loan, and the total sum payable would be Rs. 1,817,519,” informs Shetty.
How to manage money for pre-payment
If you are thinking of waiting till you land a high-paying job, it might not be such a good reason to delay paying off the loan. Employment may be hard to find in a difficult economy, and salaries are competitive.
“If you find pre-payment a stretch with your current pay-check, you might want to use your joining bonus or performance rewards to reduce your burden. You can also consider borrowing from friends and family and paying them back later. Taking up another loan to pay off your current loan must be avoided, as it will only land you in a debt spiral. You can also approach your bank for waiving off penalty on pre-payment, if there is any,” says Shetty.
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If you are able to save an extra buck, you must put it in a liquid saving instrument and use it to make quarterly payments, once you have saved enough to reduce your tenure further.