There seems to be a growing pattern among the people I speak to regarding who needs an education loan for studying abroad. Many individuals I interact with believe that wealthy families, who have ample resources, do not seek education loans.
However, my own experience with several clients have debunked this myth and offered me a different perspective. Do wealthy families consider education loans as an option? Absolutely. Let me outline the reasons why they do:
Wealthy families are mindful of how their money works for them. They evaluate decisions by weighing the cost of capital against funding it entirely by themselves.
Allow me to present my calculations on this matter:
Why Wealthy Customers Opt for Education Loans
1. Income tax benefits for eight financial years, with no upper limit on tax breaks under the Income Tax 80E rule. This effectively reduces the interest rates to around 7-8%, even in the current high-interest rate macro environment.
2. Income tax opportunity cost: No wealthy family keeps 1-2 crores sitting in their bank accounts to fund their child’s education. Liquidating assets in such cases would attract short-term or long-term capital gains tax. This increases the cost of education to 1.15X to 1.2X, without considering any other aspect at all.
3. Opportunity cost of capital invested in equity or real estate: Both these asset classes are typically viewed with a long-term perspective, offering an expected return on investment of 12-15%. Withdrawing from these investments means missing out on potential earnings at 12-15%, compared to obtaining a loan at 7-8% (after tax benefits).
4. Cash flow: We have observed that wealthy customers often have lower liquidity. They prefer to fund education through loans rather than facing the hassle of liquidating investments every few months due to stock market or real estate fluctuations and the associated tax impact.
5. TCS (Tax Collected at Source): Currently, there is a 5% TCS applicable to money remitted outside India, which will increase to 20% from 1st July ’23. However, if an education loan is availed, the TCS rate is only 0.5% instead of 20%. Although this only affects cash flow, who would want to block the extra money?
6. Accountability of the children: Wealthy families aim to instill a sense of accountability in their children. Taking a loan for education in the child’s name promotes more responsible behavior, ensuring that they don’t take this opportunity for granted. Paying back the loan on their own gives them a sense of accomplishment.
7. No foreclosure charges: In case parents wish to pay off their children’s education loan in one lump sum later on, education loans do not incur any foreclosure charges in India.
Conclusion:
If a family is considering funding education costs worth 1 crore for their child, opting for an education loan is undoubtedly a financially savvy option.
Scenario 1: Self-Funding
Effective Cost: 2.33 crores = 1 crore + 20 lakhs (TCS) + 17.6 lakhs (minimum capital gain tax for liquidating 1.17 crores worth of assets) + 96 lakhs (loss of 12% income for 8 years)
Scenario 2: Funding through Education Loan
Effective Cost: 1.36 crores = 1 crore + 0.5 lakh (TCS) + 35.71 lakhs (8% interest for 8 years)
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