As all my readers will know, I am not fond of loans by a long stretch of imagination. In general, I believe that loans should not be used for consumption and, even in a crisis situation, they should really be the last resort. If a loan is needed to acquire a high value asset like a home, my preference is to pay it off as soon as you can. However, there can be some specific situations where an Education loan can be used in an innovative manner.
Before getting into the how and why of it, let us take a look at how we normally plan for the graduation expenses for our children. Typically, this will be done over a period of 15 years or so through some equity instrument such as Mutual funds through regular SIP or other mode of investment. If you have assumed a 12 % return over a reasonably long period it is likely that you will achieve your goal targets. To be on the safe side you may want to follow something like the plan below:-
- Let us say, your estimate of your child starting his college education is in 2020 and the amount estimated over 4 years from 2020 is 12 lacs.
- Your SIP corpus has reached a level of 11 lacs now, after the current market run up.
- You can redeem your corpus in MF, put it into a safer debt fund and be quite certain that you will have the 12 lacs needed in 2020 when it is needed.
While the above is a perfectly acceptable way of doing things, it does have certain basic deficiencies which you may want to look at:-
- You are redeeming your portfolio 3 years early, to be on the safe side. This may seriously hamper the growth opportunities.
- You do not need all of 12 lacs in 2020, the requirement is over a 4 year period. It is therefore inefficient use of resources to block it in a low return debt fund etc.
- As you are not aware of what exactly your child will land up for graduation, your need for money may be more or less than the plan you have made.
One way to look at this issue afresh is to consider Education loans from Public Sector banks. Now, the earlier rates of loans were in the range of 13% and more as it was not perceived to be a safe loan by the banks. At these prices, it does not make sense to take a loan. However, there is a class of loans nowadays, which are restricted to some listed Educational institutions, where the lending rates are way lower. At the present point of time the rates are in the range of 9.5%. With this option being available to you, the plan can be sufficiently tweaked as follows:-
- Focus on the preparation of your child for competitive exams, so that he is likely to get into one of the listed colleges.
- If you think it is needed for your child, have a goal amounting to 3 lacs or so when he starts in class 11, for the expenses related to coaching for competitive exams.
- You may have earmarked an investment for your child’s graduation, but simply let it grow without getting into unproductive mechanisms of redeeming it and then putting the amount in debt instruments etc.
- At the point of time you get admission for your child, take a sanction for the full expenses through an Education loan from a PSU bank, SBI or otherwise. Make sure it is a loan where there are no pre-payment penalties.
- As far as payment goes. it will normally be every 6 months or so. As far as possible try to pay it from your active income if you are in a job or profession. If not look at whether it makes sense to redeem your equity investment to the extent of the installment of fees. The final option will be to get the Education loan disbursed for this part.
- Whenever the market goes up substantially, redeem part of your equity holdings and try to pre-pay part of the loan already disbursed.
- Over a 7 year period ( 3 years before the course and 4 years of the college), it is very likely that the markets will do well in a few years.
- In the worst case, just keep holding equity and use the Education loan to the full extent. Start paying the EMI and when the opportunity presents itself, repay as much of the loan as you can.
Of course, there will also be situations where you have not invested adequately for your child’s education. In such cases the Education loan is a boon as it will still enable your child to study in the course and college of his choice. Once he/she passes out the loan can be paid off over a period of time.
I will encourage all of you to look at this strategy. It will ensure that your investments are being used productively and you do not need to redeem them at an inopportune time.