Should you pay off your education loan early? Here’s how to decide

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Understanding education loans

Education loans are a popular and useful way of funding higher studies, such as tuition fees, accommodation, and other living expenses. Most loans come with a moratorium period, after which repayment begins once the course is finished. Even though the loans alleviate students from financial burdens during studies, they turn into a long-term source of trouble.

Pros of paying off early

Early payment of your student loan saves you a significant amount of interest. The longer the duration, the more interest you shell out. By making prepayments whenever you have surplus funds, you can reduce the principal amount earlier and lower the cost of the loan.

Another advantage is increased creditworthiness. Repayment of the loan in advance frees your credit limit and raises your credit score. This helps while borrowing future loans, such as a home or car loan. It also reduces the stress of money concerns and gives you more flexibility to invest or spend your income on personal goals.

Cons of paying off early

Educational loans have the advantage of tax relief under Section 80E of the Income-tax Act, where interest repayment can be claimed as a deduction. Prepayment of the loan may mean forgoing such tax relief.

Another consideration is opportunity cost. If the interest rate on the loan is relatively low, and you have more attractive opportunities for investing your money at higher rates of return, it may be preferable to invest rather than prepay.

How to select what's best for you

Start with examining the interest rate on your loan. If the interest rate is high, then the best choice is to repay earlier. If it is low and you can invest better, then you can choose to continue paying regular EMIs while investing the surplus.

Assess your cash flow situation as well as your financial goals. If your budget allows for additional EMIs or lump payments without affecting essential expenditures, prepayment is an effective choice. Ensure that you have an emergency fund left before you invest additional money in repayment.

It is also important to make sure that there is no prepayment charge. Even though there are no prepayment charges on most education loans, please verify from your bank or lending institution before you go ahead.

This is a spending-based, income-based, and long-term financial planning decision. A comparison between your investment options, tax savings, and the interest rate will help you make a decision that maximizes the savings and financial growth.

FAQs

Q1. Should the money be paid in advance or invested at an education loan?

If the interest rate on the loan is higher than the potential return on investment, prepaying would be better. If the interest rate is low, then investment would be better.

Q2. Will prepaying education loan impact my credit score?

Yes, it will improve your credit score because it reduces your overall debt burden.

Q3. Are there prepayment charges on education loans?

The majority of education loans have no prepayment penalty, but always best to inquire from your lender.