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There was a time when most Indians saved in bank Fixed Deposits, insurance policies and PPF accounts for various goals including child’s education. However, with the cost of education escalating rapidly and domestic education aspirations turning to international, there arises a need for inflation beating products to invest in, for securing your child’s future aspirations. With PPF rates traditionally being kept at an elevated level plus their significant benefits of offering tax free income, the recent decision to make them market linked, and subject to a quarterly review, makes PPF returns a significantly more volatile product in our view. Relying on them in isolation for goals like your child’s education will not help.

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What to do?

If you wish to send your child abroad the cost of education will be higher. To be able to beat the escalating costs and to ensure you do not fall short of funds when you are nearing your goal you must approach it in a planned manner. Choice of products is important but strategy is equally important. When you know how far the goal is and what is the current cost, apply inflation to it to know the future cost. Do not forget to factor in possible currency depreciation impacts.

Choice of products is important but strategy is equally important.

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Strategy: Equities perform well over longer terms. Therefore, keep a higher percentage allocation towards equity. Take exposure to gold as a partial currency hedge in the portfolio. As time passes move towards fixed income exposure. When you are 3 years away from the need for the monies shift all your money into fixed income to avoid a dent to your savings due to market volatility. Towards the end maintaining the amount that you have saved will be a priority rather than increasing them because education is a goal which cannot be delayed due to financial market volatility.

When you are 3 years away from the need for the monies shift all your money into fixed income to avoid a dent to your savings due to market volatility. Towards the end maintaining the amount that you have saved will be a priority rather than increasing them because education is a goal which cannot be delayed due to financial market volatility.

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Products: To start with, broadly divide your portfolio between equity, debt and gold. Based on your risk tolerance, choose products for yourself. Since education tends to be a goal that is hard to fully realize the scale of when your child is younger, ensure that you get into a flexible product that enables changes with minimal cost impacts.. On the equity side use a combination of diversified equity funds and equity ETFs . Ensure that you stay diversified between sectors, Asset Management Companies and market capitalisations. You can also look at balanced fund which have approximately 65% towards equity and rest towards debt. Avoid exposure to direct equity, unless you can give it time. On the fixed income side you can look at PPF, debt mutual funds, and bonds. For gold you can look at gold ETFs and sovereign gold bonds.

Since education tends to be a goal that is hard to fully realize the scale of when your child is younger, ensure that you get into a flexible product that enables changes with minimal cost impacts..

All in all, keep it simple and keep it flexible.

PPF still works, but only for a portion of the portfolio.

 

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Given the high and constantly escalating cost of higher education, especially for students going abroad, most parents find it difficult to fund their child’s education out of their own funds. Education loans have emerged as a highly beneficial instrument for funding this need gap.

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 Whom should you turn to?   

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Public sector banks remain the most popular source of education loans. With the RBI classifying education loans as priority-sector lending, PSU banks are more willing to lend. Private sector banks are not too enthusiastic about this loan. Non-banking financial companies—players like Credila Financial services (promoted by HDFC) and Avanse Financial Services (promoted by Dewan Housing) have also jumped into the fray. They try to compete by lending a higher amount, processing the loan faster, and by waiving the margin amount. However, their rates may be on the higher side than that of PSU banks.

What are the costs associated with the loan?  

Interest rates on education loans are usually 1.5-3 percentage points above the bank’s base rate. For example PNB (9.60-12.60%) offers one of the cheapest education loans. For SBI, the biggest lender in this domain, the rate is 11-11.30%, depending on the loan amount.

The processing fee could be 1-1.5% of the loan amount. Lenders may or may not have a prepayment charge on this loan.

According to the model education loan scheme formulated by the Indian Banks’ Association (IBA), loans up to Rs. 4.5 lakh are extended without any collateral, with just a co-borrower (usually the parent) required. For loans above Rs. 4.5 lakh and up to Rs 7.5 lakh, banks seek third-party guarantee. For loans above Rs 7.5 lakh, students and parents need to show collateral. Life insurance policies, shares, mutual funds, bank deposits, post office savings products and property papers can serve as collateral. The value of the collateral must equal the value of the loan.

According to the model education loan scheme formulated by the Indian Banks’ Association (IBA), loans up to Rs. 4.5 lakh are extended without any collateral, with just a co-borrower (usually the parent) required. For loans above Rs. 4.5 lakh and up to Rs 7.5 lakh, banks seek third-party guarantee. For loans above Rs 7.5 lakh, students and parents need to show collateral. Life insurance policies, shares, mutual funds, bank deposits, post office savings products and property papers can serve as collateral. The value of the collateral must equal the value of the loan.

All loans of above Rs. 4 lakh carry a margin money requirement: 5% on loans for studying in India and 15% on loans for foreign courses.

Women students and those admitted to a premier institute can get a discount on interest rate of around 50 basis points.

 What can you use these loans for?

The money obtained from an education loan can be used to pay for tuition fee, examination fee, library fee, hostel fees; travel expenses for going abroad; purchase of books and equipment, including a computer; and to pay the expenses for project work and study tours.  Try to take all costs into account when quoting a loan amount to the lender.

What are the eligibility criteria?

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 The borrower must be an Indian national and should have secured admission in an approved professional or technical course through an entrance test or selection process. Some banks have an age criterion (16-35 years) while others require certain minimum marks in the last qualifying exam. If you are applying to an Indian institution, it must be on the Indian Banks’ Association pre-approved list of 1,100 institutes.

Before approaching a bank or NBFC, compare their interest rates and processing fee. If you have got admission to a good institute, check if any bank has a tie-up with that institute. See if you can get preferential treatment from that bank, say, on interest rate, loan amount or collateral.

Before approaching a bank or NBFC, compare their interest rates and processing fee. If you have got admission to a good institute, check if any bank has a tie-up with that institute.

The high default rate of around 8% of the total education loan portfolio is nowadays making banks wary of giving out this loan freely and there is talk of the eligibility criteria being made stricter.

How is the loan repaid?

The bank grants a moratorium period of one year to the student after he has completed the course or six months after he has got a job, whichever is earlier. Then the loan has to be repaid within a specified tenure, which could range from 5-15 years.

The bank grants a moratorium period of one year to the student after he has completed the course or six months after he has got a job, whichever is earlier.

Banks grant an extension of up to two years if the student is unable to complete the course on time owing to factors beyond his control.

Pay the simple interest that is charged on the loan while your ward is studying. If you fail to do so, you may not get the 1 percentage point concession on the rate of interest that regular borrowers are entitled to. Doing so will also help lower your EMI.

What are the tax benefits?

The entire interest paid on an education loan (with no ceiling) is eligible for tax deduction under Section 80E of the Income Tax Act. This tax benefit is, however, available only for eight years and not more, even if the tenure is longer. No tax benefit is available on principal repayment.  To avail of the benefit of Section 80E, the loan has to be from an approved entity.

The entire interest paid on an education loan (with no ceiling) is eligible for tax deduction under Section 80E of the Income Tax Act.

What happens if you default?

Before taking an education loan, students and their parents should evaluate the job prospects and likely salary package after the completion of the course. If there is a default on an education loan, the credit score of both the student and the parents gets affected. This means that in future you will have difficulty in getting any loans and credit cards.

Before taking an education loan, students and their parents should evaluate the job prospects and likely salary package after the completion of the course. If there is a default on an education loan, the credit score of both the student and the parents gets affected.

If EMIs become due for 90 days, the loan gets classified as a non-performing asset (NPA) by the bank. Most banks wait for a month or two after the EMIs stop. If non-payment continues, they first issue a notice. Then they try to contact the loan guarantor. Only as a last step and after due notice do banks move to take possession of the collateral.

If the borrower agrees to start repayment once again, a penal interest rate of 2 percentage points over the regular interest rate is charged for the period of non-payment.

If you have difficulties in repayment, don’t try to avoid your lender. Inform him about your difficulties and try to get the loan restructured. Sometimes, banks do agree to lower the EMI and increase the tenure of the loan.

 If you have difficulties in repayment, don’t try to avoid your lender. Inform him about your difficulties and try to get the loan restructured. Sometimes, banks do agree to lower the EMI and increase the tenure of the loan.

Finally, the co-borrower (parent) should get an insurance cover equal to the loan amount, preferably a pure term insurance plan, to cover this liability.

The co-borrower (parent) should get an insurance cover equal to the loan amount, preferably a pure term insurance plan, to cover this liability.

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In the first article of this series, we had discussed the challenges you are likely to face in meeting your child’s higher education goal. Here we shall discuss the nitty-gritty of the investment planning that you need to do to achieve this goal.

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Goal setting

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Before you start saving and investing for your child’s education, you must set a goal regarding the amount of money you need to accumulate. Get an estimate of the cost of some of the major courses that your child might possibly want to pursue. To the current cost, apply an inflation rate of at least 11-12%. This will give you an idea of the amount of money you will need when your child is ready to go to college.

 Get the asset allocation right

Since this is a long-term goal for which you have at least 17-18 years, you should build an equity heavy portfolio. Around 70-75% of the child education portfolio should consist of equity or equity mutual funds. Unless you build an equity-heavy portfolio, you may not be able to earn a rate of return that beats the high inflation rate that sends the cost of education spiralling upward year upon year. Also, since this goal is a long time away, it doesn’t matter if your portfolio is equity heavy, since you can simply ignore the interim volatility.

 

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The rest of the portfolio may be invested in fixed-income instruments like Public Provident Fund (PPF), fixed deposits and tax-free bonds. If on the fixed-income side you wish to invest in debt mutual funds, choose funds whose average maturity does not exceed 4-5 years (longer duration funds will be too volatile). Among debt mutual funds you may also invest in long-term fixed maturity plans (FMPs).

Instead of using separate instruments on the equity and fixed-income sides, you could also invest in equity-oriented balanced funds. These funds maintain more than 65% allocation to equities. The advantage of investing in them is that even the debt portion of these funds receives the more favourable tax treatment that equities enjoy.

Instead of using separate instruments on the equity and fixed-income sides, you could also invest in equity-oriented balanced funds. These funds maintain more than 65% allocation to equities. The advantage of investing in them is that even the debt portion of these funds receives the more favourable tax treatment that equities enjoy.

If your goal is less than five years away, you will have to be content with using fixed-income instruments, where the return rate of return tends to be lower than from equities.

Pay heed to liquidity

When you are choosing the investment instruments for this goal, you have to be very particular about liquidity. The education goal has a peculiar nature. In the year when your child is ready to go to college, and for a few years thereafter, you will need large sums of money. The date when this money will be needed cannot be altered or pushed forward to suit your convenience. That is why the liquidity aspect becomes important. If you invest in an instrument like the PPF, ensure that the account will mature before your child is ready to go to college.

 The date when this money will be needed cannot be altered or pushed forward to suit your convenience. That is why the liquidity aspect becomes important. If you invest in an instrument like the PPF, ensure that the account will mature before your child is ready to go to college.

As you approach your goal

 About three years before your child enters college, withdraw money from the equity instruments that you have invested in. This precaution must be undertaken so that a downturn in the stock markets does not jeopardise your child’s dreams. The withdrawn corpus may be invested in less volatile instruments like short-term and ultra short-term debt funds and fixed deposits.

 About three years before your child enters college, withdraw money from the equity instruments that you have invested in.

Be well insured

Parents should also buy adequate term cover so that even in case of an unfortunate eventuality, their child’s education goal is not jeopardised. One rule of thumb is that you should buy term cover equal to at least 1.5-2 times the current cost of the education goal. For a more accurate assessment, you may need to speak to your financial planner.

Parents should also buy adequate term cover so that even in case of an unfortunate eventuality, their child’s education goal is not jeopardised.

What should you avoid?

Since the rate of inflation in education is quite high, avoid building a portfolio that is weighted in favour of fixed-income instruments like fixed deposits and recurring deposits. Investment-cum-insurance products from insurance companies may also not be suitable, especially if they are traditional plans, since their rate of return tends to be very low. It is best to buy two separate products: a term cover for your insurance needs and mutual funds for your investment needs. Branded products, which advertise themselves as being designed to help you meet your child’s education goals, whether from mutual funds or from insurance companies, offer no special advantages. It is best to go with plain-vanilla diversified equity funds that have a robust track record and relatively lower expense ratio.

Since the rate of inflation in education is quite high, avoid building a portfolio that is weighted in favour of fixed-income instruments like fixed deposits and recurring deposits. Investment-cum-insurance products from insurance companies may also not be suitable, especially if they are traditional plans, since their rate of return tends to be very low. It is best to buy two separate products: a term cover for your insurance needs and mutual funds for your investment needs.

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The cost of education is increasing at a rate faster than normal inflation. Do you have enough for your child’s education? Are you aware of the best options for doing so? Do you have to sacrifice your other goals for achieving your child’s education? Read the article by Vishal and do comment how you are planning your child’s education.image-0001

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