Education Loan interest rate is simple or compound?

✓ Calculation of Simple/Compound Interest 

✓ Tricky terms and conditions of Education Loan

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Table of content

  1. What is Simple Interest Rate?
  2. What is Compound Interest Rate?
  3. What is Partial Simple Interest Rate (PSI)?
  4. Partial Interest payment of Private Lenders
  5. How Private Lenders mislead you by utilizing ‘Simple Interest’ in their conditions
  6. Who actually accepts interest payments on a Simple Interest basis?
  7. Conclusion
  8. FAQ's
  9. Need Help? Ask Here!

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While doing their research on education loans every student comes across the terms simple interest rate and compound interest rate, how simple interest is charged during the moratorium period, and how the interest rate starts compounding after that. 

It is very important for students to clearly understand the difference between the two and exactly understand how both of them play an interconnected role in how banks charge interest on the loans they give out, how the repayment period affects the total amount you pay back, and much more. 

A clear understanding helps students understand the jargon and not be misled by the confusion banks can sometimes put students through which can end up in you paying more than you have to. Keep reading to learn more.

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What is Simple Interest Rate?

A simple interest levied on your education loan amount means that the interest will only be charged on your principal loan amount.

The formula of simple interest:
Simple interest (SI). = (P × R × T)/100

Where,
P = Principal amount (The loan amount you take)
R = The Rate of Interest charged 
T = The tenure of your loan or the period 

So when simple interest is charged

The total amount you’ll have to pay = Principal amount + Accumulated simple interest amount.

Let’s understand the concept with the help of the following example:
Your education loan amount is Rs. 10 Lakhs, and the rate of interest is 10% p.a. for 5 years. A 10% simple interest on Rs.10 Lakhs comes to Rs.1 Lakh as the annual interest amount. So, at the end of 5 years, the total loan amount would come to; Rs.10 Lakhs (Principal)+ Rs.5 Lakhs (accumulated interest amount) = Rs.15 Lakhs. Now let’s understand compound interest concerning education loans.

What is Compound Interest Rate?

A Compound interest levied on your education loan amount means that additional interest will be charged on your accumulated interest amount and the principal amount.

Formula of Compound Interest:
Compound Interest  = P ( 1 + r/n) ^ nt - P

Where,
P = Principal amount
R =  The rate of interest 
N = Number of times the ROI is compounded every year
T = Loan repayment tenure 

So when Compound Interest is charged 

The total amount you = Interest on (Principal amount + Accumulated interest amount).

Let’s try to understand this concept in terms of the same example as above.

You borrowed an education loan of Rs.10 Lakhs at 10% p.a. for 5 years. According to the compound interest terms, with annual compounding, the interest amount for the first year will be calculated as:

Rs.10 lakhs (Principal loan amt)+ Rs.1 Lakh (accumulated interest for one year) = 11 Lakhs (1st year)
Rs. 11 Lakhs + Rs.1.1 Lakh (including annual compounding)= 12.1 Lakhs (2nd year)
Rs.12.1 Lakhs + Rs. 1.21 Lakhs (annual compounding) = 13.3 Lakhs (3rd year) and so on. So, by the end of the 5th year, the student ends up paying Rs. 16.1 Lakhs as the total loan amount.

What is Partial Simple Interest Rate (PSI)?

Apart from simple and compound interest, there is another form of interest known as partial simple interest. In the case of partial simple interest, the student only pays a certain portion of the simple interest, and the remaining amount gets added to the principal amount. 

After the SI, CI, and PSI are calculated it is added to the principal amount which is the loan amount you have taken out, and the total amount or EMI is calculated. 

Total amount = Principal amount + Interest calculated on the principal amount (simple/ compound)

Partial Interest payment of Private Lenders

Coming to the partial interest payment, this feature was introduced to facilitate students who have to pay higher amounts than usual, as interest. They have considered the fact that such students may not be able to make full payment of their interest in one go.

The main talking point about this feature is that when a student only pays partial interest, then how do compensate for the rest? 

This difference between the amounts is automatically accumulated and is compounded to your principal amount. Let’s understand this with the help of an example.

When the actual interest to be paid is Rs. 12,000 per month, Credila representatives give you the offer to pay the partial interest of only Rs. 5000 every month. In this case, every month, the difference amount of Rs. 7000 is automatically added to the next month’s principal. This is exactly how compound interest works! But on the other hand, let’s assume that the student manages to pay the entire interest amount every month. In that case, there won’t be any amount left to add to the next month’s principal as compound interest.

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How Private Lenders mislead you by utilizing ‘Simple Interest’ in their conditions

Now that your basic concepts regarding simple and compound interest are clear, let’s discuss the first point where people generally go wrong. Let us consider a student who has taken a loan from a private lender that charges an education loan interest rate based on compound interest. However, there is an underlying condition for the same. The student has to pay the accumulated interest amount every year. Here is an example to help you understand this concept better.

A 10% interest rate on a loan of Rs. 10 Lakhs for 5 years, brings the interest amount to Rs.1 Lakh per year. Let’s assume that the student pays the accumulated interest amount of Rs.1 Lakh without any delay in the first year.  According to the private lender, there won’t be any compound interest levied on the loan amount in the first year as the accumulated interest has been paid without delay. Then next year again, interest will be levied on the same amount, i.e. Rs.10 Lakhs because the student has paid the accumulated interest amount of the previous year.

If this is the case then according to the conditions laid down by the respective private lender, no compounding of interest rate should happen, right? So does this mean that the student is still paying the interest amount on a simple interest basis? This is the first instance of how private lenders trick their loan applicants by misusing the concept of simple interest. 

Who actually accepts interest payments on a Simple Interest basis?

By this point in the article, I am sure this question has arisen in your mind. Don’t worry. The education loan interest rate calculation of most of the government banks is done on a simple interest basis. As opposed to private lenders, public banks calculate your monthly interest amount purely on a simple interest basis during the moratorium period (i.e. Course duration + 6 months after the course).

And also, if an applicant borrows an education loan from a public bank, he/she doesn’t even have to start paying the interest amount until after the moratorium period. You still stand to benefit from this factor. Take this for an example. Eg. If you apply for Rs.10 Lakhs loan from a public bank at a 10% interest rate p.a. Then at the end of 2 years, you still end up paying back Rs.12 Lakhs only, (Principal amount + Simple interest @10%p.a.)*2. Pretty simple and straightforward, right?

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Conclusion

When you decide to approach private lenders, keep a close check on their education loan interest rate terms and conditions. They will try to make it look like their interest rate policies are at par with public bank terms. However, by now you know that’s not the case. Know more on how you can catch these private lenders fooling you by watching the 12th episode of the Loanflix series. Our expert tells you a very simple hack on how to do it. If you do like this episode, don’t forget to watch all the previous episodes of Loanflix, a comprehensive web series on education loans and more.

Now that you've got a hang of the education loan interest rate terms and conditions, what do you do if you have borrowed an education loan from a very expensive lender and now you want to reverse your decision? How do you do it? Stay tuned for our next article, which will tell you all about the Education loan takeover.

Speak with our financial officer to get help and assistance. Also, check your eligibility for the best education loans matching your profile.

Education Loan FAQs

  • Can education loan interest rates vary depending on the course of study or program level?

    Yes, education loan interest rates can vary depending on the course of study or program level. Some lenders may offer different interest rates based on the type of program or course of study. For example, STEM programs may have lower interest rates compared to other programs. This is because STEM programs are often in high demand and have good job prospects, making them less risky for lenders.

  • Can education loan interest rates be negotiated with lenders?

    Yes, education loan interest rates can be negotiated with lenders, especially if the borrower has a good credit score or a strong financial position. By using WeMakeScholars, borrowers can definitely save time and effort in finding and negotiating education loans, and can potentially secure more favorable interest rates. We have partnered with various lenders and can help borrowers compare loan offers from different lenders to find the best interest rate and terms for their needs.

  • Can education loan interest rates be fixed or variable?

    Education loan interest rates can be either fixed or variable. Fixed rates remain the same throughout the loan term, while variable rates can change over time based on market conditions. Fixed rates provide more stability and predictability for borrowers, while variable rates may offer lower initial rates but can be subject to fluctuation.

  • What are the advantages of simple interest and disadvantage of compound interest on education loans?

    Simple interest has the advantages of being easy to understand and resulting in lower interest costs. On the other hand, compound interest has the disadvantage of higher overall interest costs and is complex to understand. The choice between simple and compound interest depends on the borrower's preferences and financial situation.

Our Education Loan team will help you with any questions

Abhinav Raj
WeMakeScholars- supported by IT Ministry, Govt. of India.
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