Student loans are distributed for the purpose of covering educational costs for attending college, and they come from both government and private lending organizations. In some cases, students who find themselves with excess money during college choose to invest student loans rather than returning them to the government. While this type of investment is not strictly illegal, it raises numerous ethical issues that result in a legal and moral gray area for aspiring student investors.
Between 1998 and 2000, a college student and inexperienced investor Chris Sacca used his student loans to generate an investment portfolio of more than $12 million, according to Inc.com. Sacca is an extreme example of the growing trend of college students who choose to divert money intended for educational expenses and attempt to generate a return in the stock market. Such a move is risky, but it’s not without its benefits, as wise investments can generate revenue that exceeds the interest on private and federal loans.
Key Takeaways
- Investing student loan money is not illegal.
- However, such investing does fall in a legal and moral gray area.
- Borrowers of government-subsidized loans could face legal action if they invest the money, which may include repaying subsidized interest.
- Private student loans have fewer restrictions and students likely won't face any recourse for investing that money.
- A bigger risk, however, might be the inability to generate sufficient return before repayment is due after graduation.
Investing Federal Government Student Loans
The biggest legal consideration when investing student loans is whether the loans are from a private lender or a U.S. Department of Education contracted lender. The Department of Education generally has stricter rules about accepted uses of student loan funds, while private lenders often trade higher interest rates for fewer restrictions.
One of the biggest differences between federal student loans and private loans is that the government subsidizes interest on some student loans as an investment in an educated population. Students who spend their federal loan money on noneducational expenses may not be breaking the law, but they could face legal action from the DOE if their actions are discovered. In some cases, this may include repaying subsidized interest.
Student Loan Amounts
The amount of student loans each student receives is based on a relatively complex formula that takes into account dependent status, parental income, yearly income, residency status and whether the student will be attending full- or part-time. The final figure is known as the cost of attendance, and it generally includes a living allowance for students who are living off-campus.
The living allowance is where the gray area of student loan use begins, as some students choose to invest student loans in excess of attendance costs in the same way that others choose to use them for unrelated living expenses. In cases where institutional scholarships cover the cost of tuition and room and board, students may find themselves with thousands of dollars in unused student loan money to return or invest.
Students who wish to invest student loans while incurring as little risk of legal action as possible should avoid investing government-subsidized loans. Investing the full amount of refunded student loans is also a risky move, and more conservative investors choose to stick to the excess amount allotted for general living expenses. While litigation is a possible risk, the real risk most student loan investors face is not being able to make a return on their investment before payments come due after graduation.
The Advisor Insight
Scott Snider, CPF®, CRPC®
Mellen Money Management LLC, Jacksonville, FL
While not strictly illegal, investing your student loan proceeds means you must beat the interest rate charged on your loan to reap any meaningful benefits. With current loan rates at 5.50% to 8.05%, the range is incredibly wide, while the historical average return of the S&P 500 dating back to 1928 is 10%. Therefore, the risk-reward tradeoff for investing the money of any loans that charge 5% or more is not enough to justify the downside potential. This risk is especially pronounced if you invest the money right before the start of a recession, which could potentially cost you the entire capital plus more. For loans that charge lower interest rates, it is advisable to focus on paying down the debt and then invest other savings instead.
FAQs
While not strictly illegal, investing your student loan proceeds means you must beat the interest rate charged on your loan to reap any meaningful benefits. With current loan rates at 5.50% to 8.05%, the range is incredibly wide, while the historical average return of the S&P 500 dating back to 1928 is 10%.
Are you allowed to invest loan money? ›
You can use a personal loan to invest, but it's not without risk. The short answer is yes — it is possible to use a personal loan for investing.
Is it a good idea to invest student loans? ›
A general rule of thumb is to invest instead of aggressively pay off your student loans if the average return on investment is higher than your student loan interest rates. A conservative but plausible return on investments is 6% per year.
Can I use student loan money for anything? ›
Ultimately, any leftover loan money is yours to use however you'd like. While you won't go to jail for spending student loan money on expenses unrelated to school, you'll likely pay more over the long run because of the extra interest that accrues (grows) on those borrowed funds.
Is it legal for my student loans to be sold? ›
While you may not want your student loan sold to another lender, there is unfortunately nothing you can do to prevent it. “Borrowers have no say in whether their loans are sold to another lender or whether the servicer can be changed,” said Kantrowitz.
What happens if you invest a personal loan? ›
While personal loans generally aren't taxable, your investment gains will be, so this, too, can eat into your earnings. Missing loan payments can hurt your credit: When borrowing to invest, you're gambling that the investment will return enough money in time for you to repay your loan.
What is it called when you borrow money to invest? ›
Borrowing to invest, also known as gearing or leverage, is a risky business. While you get bigger returns when markets go up, it leads to larger losses when markets fall. You still have to repay the investment loan and interest, even if your investment falls in value.
Is it better to invest or pay student loans? ›
Paying off your loans early will likely save you on interest expenses, though eliminating your loans doesn't mean you'll increase your future savings. Investing can potentially position you for a more secure future, but it may be risky and you'll still have loan debt.
Is it illegal to spend student loan money reddit? ›
You may use the loan money you receive only to pay for your authorized educational expenses for attendance at the school that determined you were eligible to receive the loan. Authorized expenses include the following: Evidently just not capable of being helpful.
Is it better to invest or pay off student loans first? ›
Neither option is inherently better than the other, as the "right" one to prioritize will depend on your goals and how comfortable you are having debt. Before you decide between using extra cash to either pay down student loans or invest, you'll want to ensure you fully understand your financial situation.
Sometimes, students borrow more in student loans than they need to fund their education. Students in this situation may wonder “what happens if I don't use all of my student loan?” In most cases, colleges will refund the money to the student.
What can you not spend student loans on? ›
What Can't You Use Student Loans For?
- Buying a car or motorcycle.
- Purchasing a condo or house.
- A shopping spree to ease final exam stress.
- Spring break vacations with friends (or anyone).
- Partying with friends – no matter how "essential" you think it is.
Student loans don't count as income, but borrowers could owe on portions of scholarships and grants. Student loans are not taxable income, but be aware that other types of aid are treated differently. Many students borrow money or accept grants and scholarships to help pay for higher education.
Who owns your student loans? ›
Federal student loans are owned by the U.S. Department of Education while private student loans are owned by the financial institution that granted them. Learn more how who owns student loans and how to find out who owns your student loan.
Why did my student loans disappear? ›
Why did my student loans disappear from my credit report? Your student loan disappeared from your credit report because your loan servicer made a mistake, or you fell into default more than 7 years ago. Remember, even if your loans no longer appear on your credit report, you're still legally obligated to repay them.
What to do if your student loan is sold? ›
If you receive a notice that your loan is sold, make sure the balance and terms of your loan are accurate. Contact your lender with any problems. If you can't find your loan or make payments, call your lender's customer service line right away. Track your loans with the National Student Loan Data System (NSLDS).
Can you invest in bank loans? ›
Bank loans are generally only available for large institutional investors, so most individual investors can only access the market through a mutual fund or exchange-traded fund (ETF).
How can I make money by borrowing money? ›
Debt can be used as leverage to multiply the returns of an investment but also means that losses could be higher. Margin investing allows for borrowing stock for a value above what an investor has money for with the hopes of stock appreciation.
Is it illegal for banks to loan money? ›
Lending limits set by federal statute (12 U.S.C. § 84) cap the amount of money a bank can loan to any one borrower. Currently, the limit is 15 percent of its total capital plus surplus for loans unsecured by collateral and 10 percent of the total for secured loans.
Do millionaires pay off debt or invest? ›
Millionaires typically balance both paying off debt and investing, but with a strategic approach. Their decision often depends on the interest rate of the debt versus the expected return on investments.
