There’s always a budget for every need. When planning to fund children’s higher education via an education loan, parents should know borrowing too much can lead to overleveraging. How can you avoid this? Read to find out.
With the rising cost of education, many parents turn to loans to fund their children’s education. While loans can always bring you funds to access higher education, overleveraging while borrowing remains to be a concern. There are many costs associated with education from tuition fees, and stationary, to living expenditures if you want to send your kind to a different city or abroad to study.
“When planning for your kids' education, it's important to remember that there's always a budget, says Anand Rathi, Co-Founder of MIRA Money. Borrowing too much can lead to overleveraging, which is when debt obligations exceed the borrower’s ability to repay without straining their finances.
Overleveraging happens when you take a debt that is disproportionately high compared to your income and assets. This results in an inability to meet repayment schedules without resorting to severe cutbacks. In the context of education loans, overleveraging can disrupt cash flow, delay important financial goals like retirement, and increase your risk of defaulting on the loan.
Many parents may potentially borrow without factoring in how this debt fits into their overall financial situation. In an emotional decision to ensure their child’s education, they might end up with a loan that stretches their monthly budget beyond its limits.
“While it is natural to want to spend more out of love and emotion, it's advisable not to exceed 10-15 per cent of your overall savings on education,” Rathi states.
1. What is the actual cost of education?
The cost of education is not limited to just tuition fees. There are many other expenses involved such as food, accommodation, travel, books, stationary supplies, and extracurricular activities.
If parents underestimate the total cost, they may end up borrowing more than initially planned.
Begin by creating a detailed financial forecast for the total cost of education, considering inflation rates, exchange rates (for international studies), and unanticipated expenses such as those related to health.
2. What are my limits?
“Overspending could prevent you from fully reaping the benefits,” Rathi states. If you are thinking of studying abroad it is ever more important to know your financial limits than to loan a hefty amount that you can’t repay.
Says Brajesh Mishra, Co-founder, and COO Varthana, “When parents are seeking an education loan from an NBFC, it's crucial to avoid over-borrowing and ensure that they can comfortably manage their financial commitments. One of the key factors is borrowing only what is necessary. Parents should take the time to carefully assess how much the EMI will be as a percentage of their monthly income.”
A key rule to avoid overleveraging is to make sure that your education loan repayments must not exceed 15-20 per cent of your monthly income. Minidng such a ratio will ensure that you can manage the loan without straining other financial necessities such as housing, utilities, and food.
This is also significant to avoid falling into a debt trap. Just because a lender is willing to provide you with a large loan does not mean it’s a wise financial decision. Stick to borrowing only what is necessary to cover essential education costs.
3. What are my alternatives?
Before you burrow, explore any alternative ways to fund your child’s education. Rathi says, “Financial markets are currently providing better returns compared to loans. In some cases, parents who take out loans may see a slightly better return or break even if their investments perform well. They don't have to withdraw their investments, and the loans can be used to fund education.” However, even in this case, it's crucial to avoid overleveraging, which means borrowing more than you can realistically repay.
Mishra suggests that if parents have been saving money over the years, that can act as a buffer, reducing the amount they need to borrow. “It’s always better to be conservative and ensure that there is a well-planned cash flow to manage monthly payments.”
Don’t forget to check on factors that can reduce your financial burden in education such as scholarships, grants, and work-study programs. Parents should also encourage their children to apply for merit-based scholarships or pursue part-time employment can significantly lower the amount they need to borrow.
4. What is my repayment strategy?
Repaying an education loan is often seen as the responsibility of the student after they complete their education and can secure a job. However, parents and children should collectively plan a repayment strategy.
Parents should factor in when their child will start earning and how soon they can contribute to repayments. Moreover, having an emergency fund to fall back on in case of job loss or other financial disruptions is important for you.
1. Saving Early is the Key: Setting up an education fund early on, such as through fixed deposits, mutual funds, or systematic investment plans (SIPs), can help you accumulate wealth over time. This will reduce your need for borrowing later on, as you will have already saved a significant portion of the required amount.
2. Check Interest Rates: While going for education loans, NBFCs are becoming a popular choice. NBFCs typically charge higher interest rates than traditional banks, so you should total up how costly such a loan will be for your finances. Even if you are taking a loan from a traditional bank checking the interest rate is a healthy practice.
3. Understand EMI Structure: If the total EMI from all loans becomes too high, it leaves little room for contingencies or unexpected financial shocks. Make sure you plan out repayment strategy in a way that EMIs are paid timely and do not lead to defaults.
Defaulting on loan payments can have serious consequences, especially in terms of credit ratings. A poor credit score makes it difficult and more expensive to borrow in the future, so managing finances carefully is crucial to avoid long-term financial difficulties.