Invest in a loan, reap benefits

The government’s focus on one state one IIM has led to the opening of 20 IIMs across the country. Along with the IIMs, many other business schools like XLRI, MDI, SP Jain have made their name in the Industry. These top business institutes produce more than 2,000 business school graduates every year.

The cost of doing an MBA has significantly increased from Rs 3-4 lakh in 2007 to about Rs 18-20 lakh in 2017. This makes education loans even more important as these enable students to pursue an MBA. These loans not only offer attractive interest rates, but are also disbursed without attaching any collateral. A moratorium period of two-and-a-half year on payments, for the duration of study, is also offered. However, it is surprising to note that despite all these benefits many students do not opt for an education loan even when the cost of MBA has increased manifold. A recent study indicates that the education loans disbursed in 2017 only grew by 2.7 per cent. 

Historically, the average interest rate on education loans to students of IIMs, XLRI, MDI, SP Jain has been around nine per cent per annum. The entire interest amount is allowed as deduction for a period of eight years under section 80E of the Income Tax Act. The average salary paid at schools like IIMs, XLRI, MDI, SP Jain is above Rs 15 lakh. This automatically places fresh graduates in the highest income tax slab of 30 per cent. The effective interest rate for the education loan is hence 6.3 per cent, taking into effect the tax benefits.

Some parents propose to fund the education from existing savings in fixed deposits. The average interest in a fixed deposit account is approximately eight per cent. Interest income earned on fixed deposits is considered as salary for tax purposes. The effective return on these deposits becomes 5.6 per cent instead of eight per cent.

In such a situation, it makes sense for the parents to break the fixed deposit to fund the education of their children. The lower return yielded on the fixed deposit as compared to the cost of the loan makes this decision a financially prudent one.

On the other hand, a parent might plan to fund education by diluting higher-yielding assets such as investment in equities, PPF, gold or real estate. It is highly likely that the returns from investments will easily outweigh the interest charged on the loan. In such a situation, an education loan should be availed of while existing assets should be left untouched.

In most cases, such a large amount in fixed deposits is rarely available for financing an MBA education. Thus, it makes sense to avail of the education loan and take benefit of the tax breaks and cheap loan. 

Apart from the financial prudence, a benefit for young borrowers is exposure to availing and managing credit responsibly. This also helps in managing personal finances better. A CIBIL listing with a good credit history would also help them for future loan requirements. 

It is clearly evident that the positives of going in for education loan for your MBA outweigh the costs. Perhaps the government needs to make more efforts to encourage parents and students avail the opportunity of taking student loan.

—Inputs by PGPM student Nami Patni and Prof. Anshul Jain, Assistant Professor, finance, MDI Gurugram.