Investing With Student Loan Money: Can You, Should You?August 3, 2021
One of the best ways to build wealth over time is through investing. For many students, the idea of investing with student loans can be tempting. After all, when you get student loans, you end up with a chunk of cash that you could put into the market for a potential return.
Before you decide that using student loans to invest is the right strategy for you, though, it’s important to consider the implications and make sure the benefits outweigh the risks.
Can I invest student loan money?
If you’re considering investing student loan money, it’s crucial to remember one key fact – eventually, you will be expected to repay your balance with interest. While investing with student loans isn’t technically illegal, The Department of Education does say that student loans are meant to be used for education expenses.
When you receive your financial aid offer, it’s based on the school’s estimated cost of attendance. Your actual costs might be more or less, depending on where you live, costs of your activities or additional expenses that can come with certain classes or needed equipment. In some cases, there might be money “left over” after your funds are disbursed to the school. After covering your billed expenses to the school, anything left is sent on to you.
Technically, you’re expected to use that money for educational costs, including your living expenses or buying necessary items like computers and books. However, even then, if you’re frugal, you might find that you have more money available. There’s no specific law preventing you from using student loans to invest, so you could divert some of that money to an account and begin growing your wealth.
If you choose to do that, though, be mindful of the fact that, after graduation, you’ll be expected to repay your loans. It’s important to use any additional funds wisely and stick closely to your student loan repayment plan.
Potential legal action when investing with student loans
Even though investing with student loans isn’t exactly prohibited, there is the chance that the Department of Education will find out you’re using the money for that purpose. This becomes an issue if you’re using subsidized student loans.
With subsidized federal student loans, the government is covering your interest costs while you’re in school. This essentially amounts to receiving a government benefit and then using it to invest and grow your wealth. If the Department of Education finds out, it’s possible that you could be required to repay the amount of interest that was subsidized.
When it comes to unsubsidized federal student loans, though, you might be on firmer ground. You’re not getting special treatment, so you don’t usually have to worry about repaying a portion of the loan when you end up using student loans to invest.
On top of that, you might have private student loans. While many loan providers state that you’re supposed to use the money for expenses related to your higher education, once again, there’s no real mechanism to verify that you’re using the money for its intended purpose. As a result, while legal action could be a possibility, it’s unlikely.
Some students move to reduce the chances of legal action simply by identifying the amount of money authorized for general living expenses and sticking to investing that, rather than investing the full amount of any “left over” student loan amount passed on from the school.
Risks of using student loans to invest
In addition to the slim potential of legal action when investing with student loan money, there are other risks.
Some students like the idea of investing some of their student loan money and then generating a return large enough to pay off their loans, or at least reduce them. However, there’s no guarantee of a return when you invest, so the return might not be large enough to reach goals — and could even potentially result in a loss.
Another risk is the fact that now you’re going into debt to invest. Remember that student loans are debt and come with an interest rate. When investing with debt, the hope is that you’ll be able to generate a return that offsets the interest rate you’re paying on the loan. While the stock market usually offers a long-term return that’s likely to beat student loan interest rates, it’s not guaranteed, and you could end up with student loan payments and low returns.
How to invest with student loans
On the other hand, if you take time to learn how to invest wisely, investing with student loan money could potentially put you ahead as you build wealth after college. If you decide to move forward by investing with student loans, make sure you have a plan.
- Avoid using subsidized federal student loans. This will reduce the chances of legal action and the requirement to repay the subsidized interest immediately.
- Have a plan for long-term investing. You’re more likely to ride out short-term market downturns if you have a plan for long-term investing. Consider leaving the money in to take advantage of compounding returns for retirement.
- Consider index funds. Depending on your situation, it might make sense to consider index funds for the long term rather than trying to pick stocks or invest in riskier assets like cryptocurrencies. Carefully consider your risk tolerance and make a decision that works for you.
- Plan to make student loan payments over time. Don’t rely too heavily on using your investment returns to pay off your entire student loan debt after graduation. Instead, make plans to get on a repayment plan and go from there.
- Consider refinancing your student loans later. If your investments are doing well, you can consider refinancing your student loans to a lower interest rate, making your money more effective in the market. Refinancing with ELFI might help you pay off your debt faster while still allowing you to invest.*
It’s not technically illegal to invest your student loans. However, before you decide to use student loans to invest, carefully consider your risk tolerance and options, and make sure that you’re reducing the chance of legal action. Then, if you decide to go that route, create an investment strategy that makes sense for you over the long-term.