Wednesday, December 9, 2009

Loan Payment Affordability

To me, paying for an MBA is a personal expense, rather than an investment. Therefore, I hadn't considered the repayment schedule, monthly educational loan payments or return of investment. During the US admits teleconference that was conducted on December 6, 2009, we were discussing placements, loans, lifestyle etc.

This led me to analyze the various loan options, average post ISB salary (not CTC, but in hand), the expected loan payments and the possible lifestyle. I am sharing some results of my analyses in this blog post. I would certainly appreciate feedback.

Lets take the case of an average Individual A who uses a loan of Rs 18 Lakhs to fund his ISB education.

Loan Assumptions:

Loan Amount - Rs 18,00,000
Interest Rate - 10.5% (Source: Indian Bank - ISB website)
Term - 7 Years

This would translate into a monthly payment of Rs 30,350

American financial advisors recommend that the monthly loan payment should not be in excess of 15% of your disposable income in order to maintain a standard of living commensurate with your income level i.e. you will not have to sacrifice and cut back on expenses. This would imply that a person should have disposable income of Rs 2,02,333 per month, and yes, this is disposable income (after rent, utility bills, food etc.). This would not be practical under most scenarios (assuming the individual is employed in India).

Alternatively, we can estimate the average take home pay of an ISB grad (at graduation) and calculate the percentage of his/her salary that will be spent on the education loan.

Assumptions:

Average Salary - Rs 19,00,000 (CTC)
Take home salary = 62% of CTC (Source - Great Lakes)
= Rs 11,40,000 per year or Rs 95,000 per month

Interest deduction:
Assuming a declining interest component, the interest payments during the 1st year after graduation would be approximately Rs 15,000 per month. Since Individual A belongs 30% income tax bracket, the interest can be deducted from Individual A's taxable income. Thus, he/she would save Rs 4,500 a month on taxes.

After making the educational loan payments and adjustments for tax deductions, Individual A would have approximately Rs 70,000 per month left.

As I have never worked in India, I do not know whether my assumptions are reasonable. However, I do want your opinion about the Rs 70,000 number!






15 comments:

  1. Hey Nadeem
    If i am not wrong this is based on calculation of last year.

    Average this year is 15Lacs, but it is bound to touch (read, hopefully) 20 lacs by the time we graduate out.The tuition fees is also around 20 lacs+

    The monthly EMI on interest for the duration fo study would be 20k, to be shelled out. apart from that principal repayment woudl work to be around 30k for a 5 year term, (which i am looking at)... so roughly 50 k goes out from one's monthly paycheck.
    This was part of my pre-ISB applicaiton analysis

    But again. MBA pays off in long term rather than short term..so hopefully a better paycheck from the second or third year on would compensate to maintain the desired life style..

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  2. I would like to take this assessment a little further. A couple of points that have been missed out in the analysis.

    1. You can claim income tax deduction on your education loan repayment under section 80E.
    Catch: The deduction will only be on the interest that you pay and not on the principal and the limit is for 8 years of loan repayment starting with your beginning of repayment.
    Good news: There is no limit on the interest that you claim for deduction.
    Assuming that some part of our salary will lie in the 30% income tax bracket (after section 80C,D &U deductions), any deduction claimed on our education loan will save 30% on the interest amount. So the effective interest rate comes down.

    2. The most important point about education loan which is affected by the point above. What is the optimal loan amount that I should take..(keeping personal constraints aside)
    Assuming ISB MBA will cost us around 20L which we'll fund through a combination of debt (bank loan) & equity (our funds). Now what should be the optimal mix so that we minimize the EMI while maximizing the tax benefit. A very rough calculation is as follows..
    Assume a salary structure where the taxable portion is,lets say, 20L
    After all the section 80C,D &U deductions, calculate what is the taxable income.Now to maximise your tax benefit through education loan, the interest on your loan should cover the entire income falling in the 30% taxation bracket.And corresponding to that interest, calculate the principal amount. Ideally this is the amount you should borrow.
    Hope I have not been too abstruse :). Any CAs can help us further.

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  3. I need some advice here,

    If, I have savings in tune of what ISB asks for as tution fees. Is it still advisable to opt for an education loan on full/part of expenses?

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  4. Capt. Jack Sparrow,

    It depends on what kind of return can you expect from that capital if you don't give it out as tution fees (cost of capital).

    Scenario: You give the entire tution fees from your savings

    You save: 10.5% of Interest - (30% of Interest as Income tax deduction)

    You lose: Opportunity cost (The return on that capital that you could have invested elsewhere)

    In my view, it should always be a mix of loan and your own capital as I have described in my last comment

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  5. Thanks guys for the comments.

    @Anoop - For the analyses I performed, I assumed that the 2011 salary levels would be similar to the 2008 levels. Also, the 18 lakhs that i used in the analysis assumes that the Rs 2 lakhs deposit made to ISB was out of the individual's savings.

    @Rachit - Great information. As i said, I am new to tax laws in India (I am US based). Will perform that analysis to determine the optimal debt to equity ratio hopefully later today.

    But, I did adjust numbers for the 1st yr after graduation to take interest deduction into account.

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  6. Nadeem,

    Do share your new working with us..

    ReplyDelete
  7. I am not going to throw too many numbers here (I have them nevertheless).In layman terms, we will end up with 45-48k less per month in our pocket to return 18 lac loan in 7 yrs. This considers income tax, tax benefit from loan interest and every other ambiguous thing we can imagine.

    Analysis blows up in either direction if we get a 30lac or a 10 lac package. Let's chill and get down to work when we are on campus!

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  8. The figure of 45-48K is incorrect...

    On a 18 lac loan@10.5% for 7 years, the EMI will come to around Rs 30350/month.
    Can be verified at any of the Education loan EMI calculator links of the indian banks.
    Also during the initial years, the yearly interest paid would be around 1.5 lacs. Saving of 30% on this would amount to 45k translating into a saving of close to 4k per month.

    Loan amount & financial viability is a critical decision, and its good to be well informed beforehand rather than waiting till the time we are on campus.

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  9. keep the discussion goin on guys...i am taking my first MBA lesson here only...rachit can u do detailed debt/equity ratio analysis...buddy i donn know these terms...its like greek to me...a few equations and actual no. would help immesely...

    thnx...mC

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  10. @ Nadeem: Thanks for clarification. I had assumed that we would be getting it reimbursed too. However, the amount paid can be reimbursed from a bank, in case we are interested and still taking the loan amount...

    @ Rachit:
    Hmmm interesting angle of including the Income tax part ( i missed this part earlier)... i guess the 62% assumed as take home can go up slightly considering the savings due to IT....

    @ Capt Jack Sparrow:
    Personally, i feel i would take a loan of entire amount, even if i had money to pay part of the tuition fees... Couple of reasons for the same are listed below.

    1. i can use that money as living expense during course

    2. You can get IT returns only on loan amount taken, so whatever money you are putting in from your savings, you are losing an opportunity to save 30% of it during loan repayment duration.

    3. From my experience, the loan amount is at 10.5%, but even if you put the amount in FD, you get 11.5%+ and if you mix it in a proper portfolio, you can average it at around 14-15%...so it still makes sense considering the opportunity cost of the money you are paying from your hand...in addition to point 2.

    4. Liquidity...nothing beats it... Let me say, post MBA , you get a miraculous plan to start a venture...THis money can be a handy capital....
    The advantage of liquidity can be a separate thread by itself..so let me stop it here... ;-)

    Thanks guys for the amazing insights....

    ReplyDelete
  11. @ Nadeem: Thanks for clarification. I had assumed that we would be getting it reimbursed too. However, the amount paid can be reimbursed from a bank, in case we are interested and still taking the loan amount...

    @ Rachit:
    Hmmm interesting angle of including the Income tax part ( i missed this part earlier)... i guess the 62% assumed as take home can go up slightly considering the savings due to IT....

    @ Capt Jack Sparrow:
    Personally, i feel i would take a loan of entire amount, even if i had money to pay part of the tuition fees... Couple of reasons for the same are listed below.

    1. i can use that money as living expense during course

    2. You can get IT returns only on loan amount taken, so whatever money you are putting in from your savings, you are losing an opportunity to save 30% of it during loan repayment duration.

    3. From my experience, the loan amount is at 10.5%, but even if you put the amount in FD, you get 11.5%+ and if you mix it in a proper portfolio, you can average it at around 14-15%...so it still makes sense considering the opportunity cost of the money you are paying from your hand...in addition to point 2.

    4. Liquidity...nothing beats it... Let me say, post MBA , you get a miraculous plan to start a venture...THis money can be a handy capital....
    The advantage of liquidity can be a separate thread by itself..so let me stop it here... ;-)

    Thanks guys for the amazing insights....

    ReplyDelete
  12. @ Rachit: Apologies dude, I did it for 48-60 months , not 84. Some taare zameen par issues here with 84-48! :)

    Thanks so much for doing this. I am following it closely.

    Cheers

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  13. Hey Vinayak,

    When i saw the figure of 50k yesterday, it was like someone had knocked the wind out of my sails.. :)..I was even wondering that if this is the volume of money I will have to repay every month, then would studying at ISB be financially viable for me at all..so got into a research mode last evening..

    And yes..no need of any apologies, we are all friends here..friends for life..hopefully...

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  14. @ Rachit: Hhehehehe!!!! I checked again, the figure I wrote was for 48 months. So yea, we both did our Math write, just that I wrote something silly and knocked u out for a second! :D
    All good!!!

    ReplyDelete