How to start an emergency fund while paying your education loan
To create surplus savings, you must avoid taking on any bad debt and clear your existing bad debt.
Now, at the start of your career, your education loan EMIs may make your savings difficult but later on, as your income increases, it will become easier to set aside funds for emergency purposes.
Why do you need to maintain an emergency fund?
An emergency fund helps you meet your daily expenditure in case of unforeseen eventualities. For instance, what happens if you were to suddenly lose your job? In such a case, your salary will stop but your monthly expenses and EMIs will not. Financial stress can become a threat to your mental and physical health during a job loss. Although, a long period of unemployment is less likely to happen, but finding a new job also takes time. Therefore, it is important for you to have an emergency fund large enough to meet your expenses comfortably in such situations.
How to save money for creating an emergency fund
To create surplus savings, you must avoid taking on any bad debt and clear your existing bad debt, such as credit card debt and personal loans, if any. This way the interest paid towards bad debt can be saved for creating the emergency fund.
Conservative people can save money in their savings bank account and maintain surplus balance for emergency needs. Amol Joshi, Founder, Plan Rupee Investment Services says, the biggest advantage of maintaining an emergency fund in a bank savings account is:
- Easy access to funds via a debit card;
- Secure feeling of having money readily available (because it reflects as account balance).
However, make sure you don't put too much of your 'emergency fund' money in a savings bank account as the return earned on the deposit is low. Joshi said while the interest rate is low (around 4 percent or even less), you should save money in a savings bank account only if the above two comforts are more important for you.
He further said, "Many liquid mutual fund schemes come with the facilities like debit card (easy access to funds) and easy balance checking facility via mobile apps. Moreover, return on liquid mutual funds is most likely to beat the savings account interest rate. So, if you can make this behavioural change, then gradually switch to liquid funds."
Abhinav Angirish, Founder, Investonline.in said, "Instead of putting emergency funds in a savings bank account, you can opt for a liquid mutual fund or recurring deposits. You can expect to get better return on money deposited in a liquid mutual fund or recurring deposits as compared to a savings bank account."
According to financial experts, liquid mutual funds return, and recurring deposit interest rate are most likely to beat the savings account interest rate.
Angirish said, "Investing in the recurring deposit can earn around 6-7 percent return per annum. On the other hand, liquid mutual funds can earn around 8 to 9 percent return per annum on your emergency fund. However, remember return on liquid mutual funds are market-driven. However, while selling units in liquid mutual funds no exit load is applied."
Here's how to save emergency fund while paying education loan:
1. Save according to suitability:
Most experts say while focusing on repaying your education loan or other debts, you should ideally set aside small savings from your monthly income to create an emergency fund till you make a buffer amount equal to 3-6 months' expenses (which should include the cost of education loan EMIs). You may save this money either in the beginning or end of the month, as per your suitability.
C.S.Sudheer, CEO and Founder of IndianMoney.com said, "You should ideally set aside a minimum amount, say around 10 percent of your monthly income in the emergency fund at the beginning of the month. However, you may also save at the end of the month but in such case, you need to carefully manage your living expenses so that you can at least set aside a few thousand rupees or at least 10 percent of your income at the end of the month."
He said, "While paying the education loan EMIs in time, if you earn/save any extra amount during the course of time then that amount should be used in building an emergency fund which equals to 3-6 months' living expenses."
This is the simplest way and should be doable without straining your finances. However, the first year may be the toughest, but it will eventually be the most rewarding. This is because even if your savings are small, they provide you with the base for accelerated growth in later years.
Secondly, as your income rises, your ability to save money should also increase. Therefore, as you get past the first couple of years of working, then you must also start to accelerate the pace of your emergency fund creation. Adhil Shetty, CEO, BankBazaar.com said, "You should gradually push up your savings rate to 15-20 percent from 10-15 percent of your monthly income over a period of time. By all means, save a higher percentage -25-30 percent - if you can." He said, "Keep saving through this method until you've saved at least 3-6 months' worth your current living expenses. It would be even better if you save 3-6 months' worth your current income."
After you have saved an amount equal to three-six months' worth of expenses you can either stop saving towards the emergency fund or keep saving until you have made a buffer amount equal to 6-12 months' current expense.
2. Save during the moratorium period:
After you complete your education, lenders give a relaxation of about one-year time to start re-paying education loan. This is called the moratorium period.
Gaurav Gupta, Founder & CEO, MyLoanCare said that student applicants avail education loan to pursue their higher education during the course of which the applicant is not earning and hence, they are not in a position to repay the loan. Hence, most banks offer a moratorium period for repayment of education loan in which a borrower has to start paying EMIs 12 months after the completion of the course or six months after securing a job, whichever is earlier."
The repayment tenure after moratorium period generally ranges from 5 to 7 years. "Banks give the option of paying only the monthly interest during the moratorium period or paying the entire amount in EMIs only when repayment commences after the moratorium period," Gupta added.
Therefore, as you soon as you start your job, first create an emergency fund by saving money during the moratorium period. After that, begin your EMI payments towards the education loan. Once you start paying EMIs, make sure you don't skip any of your education loan EMI payment during the tenure.
Sudheer said, "Your credit score is impacted if education loan EMIs are not repaid in time. A sudden job loss could delay EMI repayments and impact the credit score. So, in case of financial emergency, maintaining a buffer amount of at least 3 months can help you continue paying your EMIs and prevent your credit score from getting adversely impacted."
As you may not get enough income to tackle both EMI payments and creating an emergency fund simultaneously, following this approach can reduce your financial burden to an extent during initial working years.
The following is another way you can simultaneously save for an emergency fund and pay your EMIs.
3. Tax-savings approach:
The money you save through tax can be used for emergency fund creation. You must know that the interest paid on the education loan provides you tax-saving deduction under section 80E of the Income Tax Act, for the first 8 years. Hence, you can put the tax saved in this way into your emergency fund.
Points to note
- If you don't have or have an inadequate emergency fund, you risk becoming more indebted because you would have to borrow to meet living expenses in case you lose your job. Therefore, you must review your emergency fund from time to time. The reviewing process should be done in accordance with the increase in monthly expenses.
- You shouldn't stop maintaining an emergency fund after completely repaying your education loan. Make sure you have created an emergency fund for meeting daily expenses which include money spent on food, rent, utility bills and other financial goals.
- If you have a steady job and have saved enough to meet your 6 to 12 months current expenses, then prepay the education loan and save on the interest you would have had to pay on the balance loan.