Higher education is getting expensive and many of us need to take an education loan to fund higher education for children. Fortunately, all the banks offer education loan products. And, given the product nature, there are a few peculiarities about education loans. Since the student won’t earn while studying (or earn enough), education loans have interest payment and principal repayment moratorium options built in. The unpaid (or uncharged) interest gets accrued and gets added to the principal. Additionally, the interest payment on an education loan qualifies for tax benefits under Section 80E. This reduces the post-tax cost of the loan.
Education Loans Are Expensive
The education loans are expensive (i.e., higher interest by design because in many cases, the bank bets on the repayment potential of the student. And there are many risks to this. The student may not be able to complete the course for any reason or struggle to find employment.
While the parents could guarantee the loan or provide collateral for the loan, the education loan is a riskier product and the banks price it accordingly. The education loans tend to have moratorium too which makes the product riskier.
You can get a secured loan at a lower rate than an education loan. However, it is usually assumed that you won’t get tax benefit for interest payment on that secured loan. This may not be true. I read an interesting article about education loans in Business Standard a few days back, where it was argued that repayment of any loan used to fund higher education is eligible for tax benefits under Section 80E.
Let’s first look at the tax benefits under Section 80E.
What Are the Tax Benefits on Repayment of an Education Loan?
While I have written about this in an earlier post, here is a quick recap of tax benefits under Section 80E.
- The entire interest paid on an education loan is eligible for tax deduction under Section 80E. There is no numerical cap on the tax benefit.
- No benefit for principal repayment of an education loan.
- The tax benefit is available for 8 years, starting from the financial year in which you make the first interest payment.
- The loan can be for your own higher education or for the higher education of your spouse and children. However, the loan must be in your name.
What Is Considered an Education Loan?
Are tax benefits only for “education loans” offered by the banks or financial institutions? Or you can take tax benefits for any loan that has been used to fund education? Section 80E does not have any definition for education loan. It just mentions loan for the purpose of pursuing higher education.
I copy the excerpt from Section 80E
In computing the total income of an assessee, being an individual, there shall be deducted, in accordance with and subject to the provisions of this section, any amount paid by him in the previous year, out of his income chargeable to tax, by way of interest on loan taken by him from any financial institution or any approved charitable institution for the purpose of pursuing his higher education or for the purpose of higher education of his relative.
Therefore, any loan that is used for higher education of self/spouse/children is an eligible education loan for Section 80E benefits. Thus, you do not have to limit yourself to those loan options with the nomenclature of an “Education Loan”.
Why Is This Definition Important?
You may be able to get a better deal (lower interest rate or lower overall fee) than an education loan. For instance, you may be able to get a loan against property (LAP) or a loan against securities at a lower interest rate than an education loan. Since these are secured loans, these might be cheaper.
Remember These Caveats
Firstly, you must use the loan proceeds exclusively for funding the education. Usually, the fee payments are not made at one go. The fee payments are spread over many years. Therefore, you will have to withdraw your loan account accordingly or avail an overdraft facility. You may be required to prove to the tax authorities that the loan was used for education fees. If you have used the loan proceeds for multiple purposes, proving end-use could be a challenge. With education loans, the cheques are written in the name of the college or university. Thus, it is not difficult to prove the exclusive usage.
Secondly, unlike education loans (by nomenclature), there won’t be any moratorium for such loans (loans with nomenclature of an education loan). You must start paying interest from Day 1. Hence, as a student, it may not be possible for you to fund education through any other type of loan, unless you have substantial savings. However, if you are a parent taking a loan to fund your daughter’s education, you don’t need to limit yourself to an education loan for tax benefits.
Compare the all-in cost of other secured loans (you can avail) against the cost of education loan and decide accordingly.
Disclaimer: Please consult your Chartered Account (CA) before deciding upon either course of action.