Educating about Education loans
Updated: Jun 18, 2020
The costs of education in India are rising but the employability quotient isn’t. Consequently, education loans which were supposed to be a bridge between accessibility and sustainability have merely become a bandage struggling to hold both.
So, today, with everyone posting their admission letters on LinkedIn, we thought of covering education loans in India and the economics behind it.
Further, we will explore the potential impact of such loans on its borrowers and economy due to the now prevalent, ‘education loan crisis’ in India.
To help you understand how education loans work, here is a brief guide:
In case, you find yourselves incapable of paying your education fees at the moment and feel that education improves your chances of a good life and you can pay the same amount later with your increased salary, you will be tempted to take this loan. The problem is that this notion is based on too many assumptions. We will cover that in a moment. But for now, if you plan on taking this loan, upon approval, the banks disburse the borrowed amount to the college directly and apart from the tuition fee, it may even finance other expenses as college accommodation, exam fees, etc., if requested. A student is the main borrower while parents, siblings or spouse can be a co-applicant.
To be eligible for the loan from an Indian financial institution, you must be an Indian citizen, having secured admission into a legally recognized college and must have completed your higher secondary level schooling. For Indian universities, the applicant needs to finance 5% of the total fee himself while for overseas education, it is 15%. The rest can be borrowed from the bank. Now comes the tricky part, interest rates and repayment. The interest rate charged is MCLR + additional spread (within the range of 1%-3%, depending on the riskiness of the applicant and other factors). MCLR is Marginal Cost of Funds lending rate which is a benchmark rate determined and revised monthly by commercial banks and is dependent on factors like repo rate, marginal cost of funds, operating cost etc.
The total interest rate at which your loan will be sanctioned is also dependent on the tenure for which you will borrow the amount. A longer tenure is exposed to more uncertainties and hence, a higher interest rate. The repayment cycle starts just after you complete the course, while some banks provide a moratorium of 6 months after you get a job or for a year after you complete the course. (Mind you, your interest payments are still increasing during this period). The tenure opted by applicants in India is usually 5-7 years. Moreover, during the course period, the bank charges simple interest on the loan amount, which is then deducted from the total loan obligation.
When it comes to loans from public sector banks, you might get a loan between 15-30 lakhs with a rate of interest starting from 8.35% and going up to 11.8%. When it comes to private banks or NBFCs, you may even get a loan up to 75 lakhs by Axis Bank, but the rate of interest also shoots up to 12.5%. Different banks have different collateral norms but for a loan above 20 lacs, collateral is a must.
An important note: Section 80E of the I-T Act allows for a deduction on the interest paid on the repayment if you are paying the interest for yourself, spouse, children, or for whom you’re a legal guardian. This deduction is allowed for 8 years.
Okay, now as we have bombarded you with so much technical information, now we discover the dark side of education loans and the crisis that follows.
Notice how I started today’s newsletter – with a statement that accuses employability to be the cause of the education loan crisis. When we say ‘education loan crisis’, we refer to the exponentially rising number of defaults and NPA’s (Non-Performing Assets) that are being recorded in this domain. If you look at public loans for higher education, there were about NPA’s of Rs 300 crore in 2000, reaching beyond 72,000 crores today. Last year, it was estimated that 9% of all education loans extended in India are susceptible to defaults in the most ideal scenario. Just take a pause and think about the expected default rate this year when we are facing layoffs and pay cuts.
If we haven’t depressed you enough, let’s explore the reasons behind this high rate of defaults.
Blinded by the fact that education improves our chances of a good life, many applicants fail to check the average salary that the college offers, and will that be enough to pay my monthly obligations and also sustain myself (Technically, you may call it Rate of investment (ROI)). Ideally, your monthly loan obligations should not cross 50% of your monthly salary or at max 60%. (Assuming, you don’t have a freakingly high starting salary of beyond 25 Lacs P.A. and you provide for your own expenses) First-generation and low-income students perhaps contribute disproportionately to an increase in loan defaults because they are likely to borrow with unrealistic expectations about post-graduation employment opportunities.
Moreover, with due respect to them, most loans are taken for private universities owned by politicians or businessmen as the fees of these colleges is exorbitant. The quality of education here is questionable. This implies two things, One, the banks know that and thus, the interest rates are higher, which means the default probability is higher. Second, as such institutions are merely degree shops, the graduating batch is not good enough to be employable by companies. Thus this isn’t an issue of unemployment but rather employability. Now, as a result, in most cases, the graduates from such institutions either fail to get a job or they engage themselves in low paying jobs, which of course can never pay their dues. Consequently, their assets are confiscated by the bank, pushing them into shackles of poverty and bonded labour. The idea of educating one member of the family endangers the chances of even getting primary education for all the other generations that follow. This, in turn, impacts the economy and puts pressure on the government.
To give you some perspective, the highest number of defaults are from the loans lent for nursing education in India and this is because it is one of the lowest-paid jobs in India. How can they ever repay the large sum of principal they borrowed from banks with that salary and if that, then interest payments?
In most cases, the entry jobs are low paying jobs and the interest payments are so huge that without help from parents/spouse or any third party, it’s quite difficult to repay the obligations all on your own. As a thumb rule, it is advised that if you can’t finance 50% of your education, it’s better to postpone it. (Don’t hold it against us. It’s just what people say.)
However, we might be seeing a rise in the number of defaults due to a rise in the number of students moving to pursue higher education but the percentage of defaults could have been constant. Anyways, it is still too huge and unsustainable for our economy.
Threeminutes advise: If you are planning on taking such loans, please check the rates first and calculate your loan obligations as per the worst-case scenario and see if you can sustain yourself with that net income. Else, as quoted by Raghuram Rajan, with education loans, you might end up as bonded labour. There is a devil in the details.
Although we have sourced all the details from credible sources, kindly don’t base your decisions solely on this.