Why Do Many Banks Consider Student Loans Risky Investments

Why Do Many Banks Consider Student Loans Risky Investments ? The simple answer is it is not backed by any collateral. No mortgage is require to avail a student loan. It is basically an unsecured loan. So banks feel student loans are risky.

Education is necessary for everyone’s life. It lays the foundation for a better living. It brings stability and financial security together with many other benefits. But the cost of education, especially higher education, has become very costly. Hence. Students are opting more and more for education loans these days. 

Earlier, only middle-class people would opt for education loans. But now realizing the benefits of availing education loans, in addition to middle-class people, people who are well off are going for education loans. 

You have the below-mentioned benefits if you opt for education loans.

  • You have income tax benefits under section 80 E of the IT Act.
  • You are responsible for your education.
  • You can save the property and money of your parents.
  • You can build good credit history.

Seeing the above advantages, students go for education loans instead of using their own money, even if their parents have a good bank balance. The banks are the institutions that provide education loans. But the banks consider it risky to invest in education loans.

To understand why the banks are hesitant to provide student loan or feel it as a risky investment let us go through this detailed article.

Also Read: How Much Money Does A College Student Need Per Month For Survival?

Why Do Many Banks Consider Student Loans Risky Investments ?

As we have said at the beginning of this article, student loans are not secured by any collateral. Also when people are in college, they really don’t have a credit score. Thus there is no scope for banks to build a trust factor.

Usually students don’t have any property or asset on their name. So if a particular student fails to make to payments, bank can’t really seize anything. Also student loans in most countries are regulated by Government, and government does not provide any type of insurance for student loans.

After a person finishes his/her studies, if they have incurred any student loan, banks usually provide a buffer period of 2-3 years to start the repayment of the loan. But if someone is jobless even after the buffer period, they won’t be able to pay. In that case it becomes a bad debt for banks.

Because of all these reasons Banks Consider Student Loans Risky Investments.

Education Loan in India

The education loan system in India comes under the CML category, i.e., Conventional Mortgage type Loans. In this category, the period to repay the loan, the monthly schedule, and the interest rate depend on the loan agreement, no matter what the student earns after the course.

Most banks offer loans as per the Indian Banks Association’s model of education loans to pursue studies either in India or abroad. The model includes the below-mentioned points.

  • The borrower need not provide collateral for a loan less than ₹4,00,000.
  • For loans up to ₹7,50,000, the borrower has to provide collateral as a 3rd party guarantor.
  • Education loans for more than ₹7,50,000 need collateral. The banks feel collecting the principal amount with their interest for loans up to 7.5 lakhs is difficult. It is because the student provides no tangible collateral. So the banks prefer to give the loans for higher amounts where the students must provide an asset as security.

Also Read: The Importance Of Financial Planning For Students

American Student Loan Debt Statistics

  • As of 30th May 2022, the total student loan debt in the USA sums up to $ 1.76. Trillion.
  • The US $37,014 is the average federal student loan debt balance.
  • The US $40,904 is the average student debt balance, including private loans.
  • In Federal debt, 7.8% is in defaulted loans.
  • For Completing a bachelor’s degree, a student borrows an average of US $30,030.
American Student Loan Debt Statistics

Also Read: High Paying Effortless Part Time Jobs in USA For International Students

Why Do Banks Consider Investing in Education Loans Risky?

The student loan has no collateral. Also, students belong to that young group of people who do not have credit or any property. So, banks find it a risky proposition to invest in student loans. Moreover, the interest rate on education loans is high. Also, getting a well-paying job is necessary to start paying back the loan on time. All these make it difficult for students to repay their loans on time. 

Indian Banks’ Association reported that non-performing assets (NPA) in the education sector rose to 8.97% at the end of March 2018, while it stood at 7.29% in March 2016. A non-performing asset is a loan for which the principal amount of interest is pending for more than 90 days.

In the financial year 2020, NPA for education loans was 07.61%. In 2019, NPA was 8.29%, and in 2018, it was. 8.11%. The NPA in the education loan sector is much more than that in the housing and vehicle loan, consumer durable, and retail loans sector. The NPA was between 1.52 to 6.91% in FY 2019- 20.

Source: Finance ministry response in Parliament, RBI

The above statistics clearly show why the banks consider investing in education loans risky.

Also Read: What Is The Best Age To Start Investing

Why Are Student Loans Considered Unsecured?

In India, the student loan amount is less than ₹7,50,000. There is no collateral required. If a borrower fails to make a payment, the bank cannot seize any asset or property for the same amount. Hence, student loans fall under the unsecured category. If all the procedures of collection fail, the banks take legal action.

Also Read: How Much A Student Can Earn In The USA While Studying

What is The Biggest Problem With Student Loans ?

Both lender and borrower are at risk

Both lender and borrower are at risk. The student can repay the loan only after getting a job and completing the course. The student fails to pay the loan on time if he does not complete his studies. On the other hand, the lender has to face default payments. The student faces a lot of pressure because he finds it difficult to pay the loan as he has no good job. His credit score will be affected.

Absence of collateral

For loans up to ₹4,00,000, the borrower need not provide collateral. It is a risky proposition for the lender. For the loans above ₹4,00,000, the borrower has to provide collateral as a 3rd party guarantor or tangible collateral. As a student, it is not easy to provide 3rd person guarantee or collateral.

At times, the loan sanctioned by the bank is lesser than the actual fees of the educational institution. So, the student needs to look for other sources to make up for whatever is not sanctioned by the bank. The banks play it safe and give a partial amount. As the risk of default is high, the bank provides that amount, which it feels is reasonable, and does not pay the entire fees.

Also Read: Loan Against Structured Settlement

Final Words !

The banks find investing in student loans risky because of the absence of collateral from the borrower. The higher percentage of NPA in student loans, compared to other categories, clearly shows why the banks are reluctant to provide education loans with no security.

As a responsible student, make sure to pay the loan amount and the interest on time unless there is any genuine reason. Inform the banks or lender if you are unable to make timely payments. 

They will restructure your payment and will reduce your burden and worries. You also in still confidence in the banks that you intend to pay the money back. It will bring down the NPAs, and the banks will have less to worry about giving loans to students. In turn, they help the entire student community to reap the benefits of student loans to pursue their education in the best universities.

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