Investing student loans has been a hot button issue for many years. At the peak of the stock market in 2006, it was a commonly held belief that investing student loans was a wise and safe decision. Then the recession happened, and a lot of students regretted that. Fast forward to today, and we're coming off a huge bull market, followed by a big stock market correction.
Investors are much more skeptical and cautious. The question remains however, "Can you invest student loans?"
What the Department of Education Says
For the sake of this article, let's assume that we are talking about Federal student loans. This will include Federal unsubsidized and subsidized Stafford Loans, Federal Perkins Loans, Parent PLUS loans, and Grad PLUS loans. These are all loans that are originated from the Department of Education and (with the exception of the Perkins Loan) paid back through a Department of Education contracted loan servicer.
According to Direct Loans, student loans are intended to be used for "educational expenses". College financial aid offices assign a cost of attendance or budget, to each student. A budget is simply the maximum amount of financial aid that a person can receive based on their residency and commuting status. When a student receives any component of their financial aid package it is assigned to the overall fees due on their student bill. They can be awarded financial aid up to their cost of attendance. Once all of the student fees have been met, students can potentially receive a refund back from their financial aid as long as their cost of attendance has not been met.
This is how it is possible for students to receive thousands of dollars in refund checks each semester.
Note: This refund is typically supposed to be used for expenses not paid through the university - such as rent payments to private landlords, food expenses, etc.
There is also no reconciliation of what these funds were used for. No audit, no money trail, no reporting. As long as the "cost of attendance" has not been exceeded, the funds are fair game according to the Department of Education.
Let's avoid getting into a political discussion at this point, and assuming that we are perfectly happy to abide by the rules of the Department of Education.
This means that we can potentially use student loans to invest!
How to Begin Investing Student Loans
The first step to investing your student loans is to get the funds to invest.
Let's take a typical loan amount for a college sophomore and walk through the entire life cycle of how this will work.
Arnie P. is a sophomore who is an in-state resident and receives an academic scholarship that covers 100% of his tuition and fees. Arnie P. is money savvy and wants to invest student loans. He qualifies for the Federal DIRECT subsidized loan of $4,500 per academic year, or $2,250 per semester. Since his academic scholarships cover all of his student fees, he is able to receive the entire student loan amount back in a refund.
Arnie's loan is disbursed and the Feds take their origination fee of 1%, which will net Arnie $2,227.50 each semester to invest. Unfortunately, before Arnie invests his first dollar he is already $22.50 in the hole.
Arnie opens up an account with any online stock broker and funds his account with his $2,227.50. He thens begins to research his investments.
Arnie P is aware thathe only has a limited window for investing to yield maximum results. Since he has taken out a subsidized Stafford loan, the Department of Education pays the interest on this loan while Arnie is in school. He also has a 6 month grace period after he graduates, before he has to begin paying this loan back. This would essentially give Arnie 3 years and 6 months to invest these funds interest free.
If Arnie invests well, he will still have his original investment available when he has to begin repayment on his Stafford loans. He can then decide if he wants to keep the funds in his investment account, and simply make the monthly payments back to his lender, which being charged interest, or if he wants to cash out his original investment to payoff his loan in full. He will get to keep any profit however!
The Bottom line
Investing in the stock market is always a risky business. Sure, there are ways to minimize this risk, but the stock market is still volatile and the funds invested there are never guaranteed.
You may be able to swing a profit by investing your student loan refunds. You are however borrowing money and using it to invest, which is generally never a good idea.
The choice is yours!
Have you tried this? Would you recommend your children try this? Do you think this is the dumbest idea you have ever heard of?
DJ works in financial services at a large public university. He lives in the Southeast with his wife and young daughter.
Editor: Robert Farrington