Why Educational Loan amount shouldn't scare you
Over the last few months, I've seen a lot of discussion about how fees - and loan amounts - compare against average packages at an IIM, including RoI calculations.
Part of that fear, I believe, is unnecessary.
This is not to deny the impact a heavy educational loan can have on you. Unfortunately, debt is - and will always be - scary. It should be. However, it shouldn't stop you from pursuing a career path which is rewarding in the long term.
The key to remember about packages at placement is that they aren't your salaries forever.
They are starter salaries.
The usual increment for an above avarage performer in most corporates is 10-15%. However, most people stay with their first company for 3-4 years (sometimes less) and then join another firm for a jump in level.
And a commensurate jump in pay, which could range from 25% to 40%.
Let's take a practical example. A student joins an institute and takes a loan of 25 L. 10.5% interest, 5 year tenure. They get placed at a job with a fixed pay of 20L and a variable component of 5L.
The total amount they have to pay as principal + interest is about 6.44 lakh per year. Income tax (assuming they get the full bonus) is 3.43 lakh (new regime).
First year is cut-to-cut. Effective amount in hand after tax and loan payments is about 83k, in which all lvliving expenses have to be considered. At the end of the year, you get a bonus of 3.75 lakh (after tax).
Second year, assume a 10% increment. New package: 22 fixed + 5.5 variable. Monthly take home after loan and tax? 107k.
Salary increased by 10%, but loan EMI stayed the same. As a result your net earnings actually accelerate faster. And at the end of year 2, you have another bonus of about 4.12 lakh.
This is where two things tend to happen.
- You accelerate repayment by using your savings to prepay the loan. Impact: number of instalments drops drastically. Assume you spent 6 lakh towards prepayment, your pending tenure drops from 36 months to 22 months. (Total bonus amount earned is 3.75 +4.12 so far).
This single step significantly reduces your stress level more than anything else. Which leads us to step 2.
- You start looking for a new opportunity, either internally or externally.
Internal role jumps after 2 years are quite common. Tjhey typically carry an additional 15% hike.
External ones are even better. A job change resets expectations and can net you as much as a 20-25% jump in a year.
Which means you go into year 3 with a compensation of 26.4 fixed + 6.6 variable.
This moves your in-hand post EMI payment to 131k p.m. Which is a significant jump over where you started - which was 83k p.m.
Assume you end year 3 with a 10% increment (pretty standard). You're now at 29.6 L fixed + 7.3 L variable. You saved 5L from your bonus. At the start of year 4, your outstanding loan balance is approx. 5.8 lakhs.
You can prepay the entire amount from your savings at this stage, getting to debt free within 3 years of graduation (with just 1 job change assumed). Or you can save the lumpsum bonus and pay off the EMIs of 53k per month, leaving you with a take home of 148k p.m. for Year 4.
This means that your effective take home (after loan amount and savings) went 83k to 107k to 131k to 148k and then, somewhere around Month 11 (when the loan finishes) it shoots up to 202k (since you no longer have EMI to worry about).
This acceleration of in hand plays out over a 3-4 year period; it mostly holds true for any role where the total CTC is about 1:1 against loan amount. (You can try the same calculations for different ratios.)
The real fun starts from Year 4 or 5 onwards, when a candidate gets labeled as an experienced resource and can qualify for higher impact - and much higher pay - roles.
RoI is calculated assuming that investment and returns are fixed. Compensation tends to grow continuously - which is why the standard calculations showing institute fees and average package don't tell the whole story.