Can You Invest Student Loan Funds?
Student loans are offered to people who need assistance to fund higher education. It is provided both by government and private organizations to cover the costs of educational expenses. There are different types of student loans offered by the Federal Government which include subsidized and unsubsidized loans.
The funds are meant to cover the cost of attendance. This includes tuition, fees, books and supplies, and room and board. The college’s financial aid office allocates a cost of attendance per student which is basically an estimate of the financial aid the student can receive based on their financial, residency, and commuting status. When the student loan is disbursed, it is sent directly to the college to cover all the expenses. If any money is left after meeting these necessities, it is returned back to the student.
While it is not illegal to invest the excess funds in something else, it poses a great risk. If you have a private student loan, there aren’t many restrictions and you won’t likely face any legal recourse for investing the money. However, if you have a subsidized federal government loan, you may face legal action and be asked to pay subsidized interest.
Although investing student loans isn’t illegal, it always carries the risk of not being able to generate enough returns before your repayment starts. In addition, stock markets and investment portfolios are volatile and fluctuate often.
Federal vs Private Loans
A major factor to consider before investing student loans is determining if the loan is from the federal government or a private lender. Compared to private lenders, the US Department of Education has stricter rules about the usage of disbursed student loan funds.
It clearly states that student loans are meant to be used to cover “educational expenses”. Most federal loans offer low rates of interest and are offered to students from low-income groups. On the other hand, private loans have lower restrictions, but they charge a comparatively higher rate of interest.
When it comes to federal loans, the Federal Government subsidizes interest in most cases and offers lenient repayment terms.
Private lenders don’t subsidize interest rates and have rather stringent repayment terms.
If you have an unsubsidized student loan and use it for noneducational purposes, you might not be breaking the law, but you stand a chance of facing legal action from the Department of Education, if discovered. In most cases, this legal action includes repaying the subsidized interest to the government.
There are two main risks involved in investing student loan proceeds:
- Legal Action - If you have taken a subsidized federal student loan and use the money for anything other than covering the costs of education, the US Department of Education may take legal action. This is because the government subsidizes the interest of these loans. If discovered, you may face legal repercussions which can include repayment of the subsidized interest in full.
- Unable To Pay Back - Investment is a risky affair. Let’s say you invest the leftover funds with a goal of generating some excess returns, but the market collapses and you lose the money. Or, the revenue or interest you generated from the investment doesn’t match up to the actual interest of the loan. In either case, you’ll find it extremely difficult to repay the loan as per the agreed upon timeline, thus increasing debt and landing in further legal troubles.
COA: A Potential Middle Ground
COA stands for Cost Of Attendance. It isn’t the bill that the college provides you, but the total expenses that you’re estimated to incur every academic year. The COA is the sum total of the costs of tuition and fees, books and study materials, room and board, transportation, loan fees, and dependent care.
Amidst all of these, the living allowance (room and board) is the gray area. You can invest this allowance, although it can be risky. If you have a scholarship or a grant covering the costs of room and board, you’ll have excess funds from the loan. However, you might want to refrain from using subsidized loans for investment or investing all of the excess funds. Other than litigation, the most common risk is that of not being able to generate enough returns before the repayment term starts after graduation.
While not exactly illegal, investing student loans is highly risky. You must be able to compete with the interest rates charged on the loan in order to reap any benefits. Depending on the rate you’re charged and the repayment terms, finding such an investment for a limited time is extremely difficult.
If you are lucky, you may earn some profit by investing the loan refunds, but bear in mind that investing borrowed money is seldom a good idea.