How do banks calculate Interest on Education Loan in India? In India, interest calculation of education loan is done in two parts. If you keep paying your interest from the very first month, then the interest would be calculated as Simple Interest, unlike other loans, wherein you pay compound interest from day 1 with no choice. However, if you do not pay your interest every month, then the interest would be calculated as Compounded Interest. So, choice is yours, would like to pay interest less or more?
Lets calculate interest:
During moratorium period, Simple Interest is calculated on the amount which you have already taken for your fees. Remember, in school maths, there use to be a formula for simple interest? Right, the same one, that is
where, SI=Simple Interest
R=Rate of Interest, here it would be per annum always
T=Time, here it would be in days always
Therefore, now the formula will be
Now, lets say, your education loan amount is Rs.4.00 lakhs. Loan tenure is 15 years after moratorium period. And, your course duration is 4 years. It means your moratorium period will be 4 years + 12 months, which is equal to 5 years or 60 months, in case of your unemployment after course completion. If you have secured employment, in that case, your moratorium period will be 4 years + 6 months after securing job, which makes a total of 4.6 years or 54 months.
- Now, for instance, on Nov 04, 2016 you have requested for Rs. 1.00 lakh for your 1st semester fees. Once this amount gets debited from your loan account on Nov 04, 2016, you will be start charging simple interest on this Rs. 1.00 lakh from 4th day of Nov 2016. Lets calculate Interest now. As per formula,
R=9.35+1.50=10.85% per annum (Please check the latest Rate of Interest from the Bank)
T=27 Days i.e. from Nov 4, 2016 to Nov 30, 2016
That means, the Simple Interest which you need to pay on Dec 1, 2016, is
SI=(100000×10.85×27)36600 = Rs.800.00,
Note: Here, instead of 365 Days, 366 Days are taken for calculation, because, 2016 is a leap year.
- If you do not pay this interest amount on Dec 1, 2016, then Dec 1, 2016 onward, your principal amount would become Rs.100800.00, and interest for Dec 206 will be calculated on this principal.
- Now, you have requested your 2nd semester fees on Apr 4, 2017. The amount of the fees is Rs.1.00 lakhs.
How, the Interest will be calculated this time, lets see.
- If you keep paying your monthly interest every month, in that case your principal amount should remain same, that is Rs.1.00 lakh, and we will assume the same so that you can understand the calculation better.
- Previous outstanding of Rs.1.00 lakh and, new outstanding of Rs.1.00 lakhs, so total principal amount will be Rs.2.00 lakhs. Now, as per formula,
Therefore, SI=(200000×10.85×27)/36500 = Rs.1605.00
During your moratorium period, calculation of SI will done in the same way. This was the one part of the calculation. Now, lets proceed to the 2nd part.
Once your repayment starts, that is the repayment of 1st EMI, then, interest will be compounded annually. Lets see how?
- Lets say, when your repayment starts, your outstanding is Rs.4.00 lakhs, as you kept repaying interest in every month during your moratorium period. On this principal, compound interest will be calculated for 15 years @ 10.85% pa to convert the total amount of Principal & Interest both, into monthly EMI, which is a fixed amount and can’t be changed. So, now the amount which you will be paying as EMI every month, will be calculated using below mentioned formula:
Amount = P 1 +R/100^n
where, P=Principal amount, that is the total outstanding
R=Rate of Interest, here its 10.85% pa
n=Loan Tenure, here its 15 years
So, the calculation of EMI will be somewhat like this:
Hence, your EMI for next 180 months or 15 years is Rs.4508.80. And, this calculation is valid only, if you are simultaneously repaying your monthly interest during moratorium period. If you want, you can always consider prepayment option. In case of PSU Banks there is no charge for prepayment, however, Private sector banks charge some extra amount for prepayment. So, this option varies bank to bank. There are many apps available for EMI Calculation, so you can always calculate Interest before you plan for any loan.
One very important thing which I would love to discuss here. And, that’s the tax benefit on the interest amount of your education loan under Section 80(E) of Income Tax Act . Repayment of monthly interest is mandate to avail this benefit. And, this is the best strategy to repay your student loan on time.
I have tried to explain this complicated calculation in most simple way. Please, comment below to add to the topic or for any queries.