Loan Basics: Pay off your study loan early

Education loans are much sought after in India, with increasing tuition fees and study expenses. While colleges have increased the cost of study on one side, companies that recruit students have also started offering higher salaries. But sometimes, you may be unlucky in your first job and get one that pays very little.

In some companies, even full-time employees earn a stipend for the initial phase (six months or one year) in the place of a regular salary.

So, how should borrowers deal with education loans in the case of those earning a stipend or have inadequate income? Should they make use of the moratorium period to postpone repayment of the loan?

It’s imperative to first understand how education loans work.

Education loans work differently compared to other loans. What is unique is the pattern of interest calculation and repayment terms.

The repayment of the principal of the loan usually commences after the completion of the education course for which the loan is taken. In most cases, repayment commences either one year after completion of the course or six months after getting a job, whichever is earlier. This time period varies with lenders. Further, during the moratorium period, banks usually charge (and you pay) a simple interest on the amount borrowed. Therefore, when your repayment starts, the original amount of loan borrowed will be the amount reckoned towards repayment.

On the other hand, some banks do not charge an interest during the moratorium period. But accumulated interest during this period will be added to the loan amount when the repayment commences.

Therefore, in such a case, the borrower will be repaying more over the loan tenure compared to the first option. It is therefore always recommended to service a simple interest on the loan during the moratorium period. The uniqueness in terms of education loans opens up different options to the borrower while repaying. For someone who does not earn a salary, but only a stipend, it may be tempting to commence repayment only when a regular salary starts kicking in.

However, as mentioned earlier, remember that the more you delay repayment, the higher will be your cash outflow. Try to commence repayment as soon as you land a job. If the stipend is very high, one can also explore the option of partly prepaying the loan.

In the case of summer interns, it would be worth exploring the option of part-payment of the principal during their internship.

For example, assume that a student has borrowed ₹10 lakh as education loan for a two-year course at an interest rate of 14 per cent per annum and tenure of five years after the moratorium period.

The bank disburses ₹5 lakh in the first year and another ₹5 lakh in the second. Normally, the student will pay ₹2,10,000 as simple interest during the course period of two years.

Now let’s say luck smiles on him and he snaps up a summer internship at the end of year one, with a stipend of ₹1 lakh a month for two months. He can then choose to repay ₹1 lakh of the loan. As a result, the simple interest he pays during the moratorium will be ₹1,96,000 only, as he has already repaid ₹1 lakh at the end of year one.

Note that while most banks do not charge a pre-payment penalty, some do levy this or restrict pre-payment for a limited time period. Check the terms of the loan first before borrowing.

Recent trends show that the difference between stipends and salaries has shrunk further, with many companies offering a stipend that is 10-15 per cent higher than the previous year’s offers. Further, many companies have also sought to increase the number of summer interns they recruit from top engineering colleges and business schools across the country.

A higher stipend is a huge positive when you start working, as you are left with a higher cash flow.

This surplus, if used to part pre-pay your education loan, will not only reduce interest outflow, but will also lead to a healthier balance sheet when you start earning a salary.

The writer is CEO, BankBazaar.com

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