5 Tips for managing education loan repayments effectively

The easy availability of education loans empowers individuals to pursue their academic goals. However, a loan is a financial liability that, if not managed well, can quickly spiral into a debt trap. Thus, having a well-thought-out repayment plan is crucial. This article will highlight some important steps for managing loan repayments effectively, ensuring a smooth, stress-free transition into professional life.

How to repay an education loan? 

1. Understand your loan details and financial obligations 

To create a robust financial plan for repaying your education loan, you must be well aware of your loan’s terms and conditions, especially the hidden ones. Knowing your principal amount, interest component and resulting Equated Monthly Instalment (EMI) helps you accommodate loan obligations within your overall monthly budget. This reduces the likelihood of defaulting on your repayment. 

For instance, there are two types of interest rates: floating and fixed. Floating rates fluctuate throughout the loan tenure, whereas fixed rates remain unchanged. Knowing the type applicable to you ensures you account for the right amount in your budget. 

Additionally, familiarising yourself with terms such as the moratorium period, foreclosure, and prepayment options helps you make important decisions affecting your loan tenure and, ultimately, your total interest cost. 

As all these terms are clearly outlined in your loan agreement, it is crucial to read the document carefully. For further clarifications, you can reach out to your lender at any time. Moreover, you can use tools such as an EMI calculator to determine your financial obligations. 

2. Clear financial goals with defined timelines 

Once you understand your financial obligations toward your education loan, you must define your targets, such as aiming to close the loan within 10 years. Setting realistic goals and timelines is essential to ensure a smooth repayment process. 

Start by taking stock of your income and expenses and ascertaining how much you can set aside for your goal each month. You must remember that shorter loan tenures mean higher EMIs but lower total interest, whereas longer tenures lead to lower EMI costs but higher overall interest.

Although the loan tenure and EMI are typically fixed at the beginning, there are ways to alter them. For instance, you can start paying during the moratorium period and close your loan earlier. 

A moratorium period is a grace period during which you are not obligated to make repayments, although the interest keeps accruing. It begins when you take the loan and usually extends up to six months to one year after the end of your course. Alternatively, you can choose to prepay your loan after the moratorium period. However, this may be subject to a lock-in period and penalties. 

3. Maximise tax savings through interest payments 

While an education loan is a liability, it also gives you an opportunity to save taxes. You can make the most of tax benefits until you repay or prepay your loan. The amount you pay as interest on an education loan can be claimed as a deduction under Section 80E of the Income Tax Act, 1961. This deduction can be claimed for a maximum of eight years, starting from the year repayment begins, or until the loan is repaid, whichever is earlier. There is no upper limit on the amount you can claim as a deduction. However, the deduction applies only to the interest component, not the principal amount. 

4. Make the most of investments to build wealth 

Unlike other types of loans, education loan repayments do not begin immediately, allowing you a repayment holiday. You can consider making investments during this period to build a repayment fund to pay off your loan early. There are several investments you can consider, but stock trading offers high growth potential. Moreover, they allow you to invest across sectors, companies, themes, market cap, etc. and enjoy diversification.

There are two ways to invest in the stock market: direct equity and equity mutual funds. To invest in the stock market directly, you must have the time and expertise to carefully select promising stocks. You will also need a separate demat and trading account. 

On the other hand, mutual funds are managed by expert fund managers who analyse trends, identify opportunities, and execute strategies to navigate market fluctuation and optimise risk-adjusted returns. Mutual funds also allow you to invest through Systematic Investment Plans (SIPs) and spread your investment across the year. 

Equity-inked Savings Schemes (ELSS funds) are equity-oriented mutual fund schemes that not only help with wealth creation but also allow you to save tax on investments up to Rs 1.5 lakh per financial year. 

Thus, until you repay your loan, you can maximise tax savings by claiming deductions on both interest repayments and ELSS contributions.  

5. Leverage compounding to build a repayment fund 

While considering investments to build your loan repayment fund is a good strategy, you must keep certain key points in mind. Investments help your money grow because of compounding – a concept where you earn returns on your principal as well as on the returns that keep accumulating. Over time, this helps create a substantial corpus. However, to harness the power of compounding, you must start investing early, stay consistent with your investments, and avoid withdrawing until you reach your goal.

Should you prepay your education loan? 

Prepaying the loan comes with pros and cons. When you prepay your loan, you save on interest costs by reducing the loan tenure, allowing you to enjoy a debt-free, stress-free life sooner. However, it may also mean losing tax benefits on interest payments and missing out on potential opportunities to invest the money elsewhere to earn higher returns. Moreover, prepayments may also be subject to penalties, depending on your loan terms. Ultimately, the decision depends on your financial situation, goals, and the specific loan terms. 

Making a decision 

Education or student loans are one of the most popular ways of funding higher education. However, to avoid financial stress, it is important to manage repayments well. By understanding your loan terms, setting clear goals, exploring tax-saving opportunities, and investing early, you can navigate repayments with ease.