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.
Fast forward to today, with the bull market running in full force again, and 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. 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.
Step 1:
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.
Step 2:
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.
Step 3:
Arnie opens up an account with Scottrade or any other online stock broker and funds his account with his $2,227.50. He thens begins to research his investments.
Step 4:
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.
Step 5:
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? Wuuld you recommend your children try this? Do you think this is the dumbest idea you have ever heard of?
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Yeah, I kindof did this, but I just kept the money in savings to have a bigger cash buffer. Then when I graduated I taught for a year and actually had part of the loans forgiven because I taught in a high needs area. So I ended up having more forgiven than was charged in interest to the loans.
Not the best investment I’ve ever made, but it wasn’t a complete wash.
@Mrs.Pop – Stocking this money away in a savings account is also a good idea. I would just be careful if you are paying interest on those student loans. With the low rates of returns on savings accounts these days, you were likely losing money just letting your money sit in a savings account, while still being charged interest on it!
It depends on your educational plans and major. Generally I would say no. But…
I have degrees in the sciences and I never had any loans. Later, when I was a post-doc, I discovered that there were Federal loan repayment programs. Up to $35K per year for doing what I was already doing – ie being a postdoc. Kind of makes me wonder if I should have taken out some loans and lived a little bit more and maybe invested some as well.
But then again, if I didn’t get accepted to the loan repayment program, I’d be stuck with loans.
@My Financial Independence Journey – Investing loans is definitely a gamble. It sounds like you came out on the right side of the equation. You are right though, there are a number of loan repayment or forgiveness options available these days through the Federal Gov’t and other sources.
If you have a degree in STEM, you can almost always get a TA, RA, or fellowship to cover your grad school, and since postdocs pay half what industry pays, you’re better off not having the debt and going into industry than betting on a loan repayment program.
@Jenny – Getting a fellowship is an awesome route to take, if you are able. My plan above would work best mainly for undergrads. You are right though, that it’s always a safe bet to avoid the debt in the first place!
I know you said no politics but its hard to resist. If the loan is for educational purposes that’s what it should be spent on. For every savvy investor there are probably plenty that aren’t savvy. These will either invest poorly or just “blow” the money.
I know this is not PC but too much money is being thrown around with no realistic spending controls. How about lower tuition? How about making the educational monopolies live in the same world that you and I live in.
@Mike Craig – I tend to agree with you. Unfortunately, the fact remains that there are virtually no checks and balances or audits on what is done with student loan money after it is disbursed to the student. As long as the money is within a student’s cost of attendance, they are ok to receive it per federal regulations. In my opinion, this is what has contributed to the massive amount of student loan debt that the average student is saddled with. You raise some great arguments.
Suddenly, getting a college loan doesn’t seem so bad. I just have to know who to invest with 🙂
I like how you used a picture looking North from Old Main at Arizona State in your article.
I had a GI Bill that paid for law school. The rule is that schools (and the government) cannot count the GI Bill against veterans when offering financial aid. So I got scholarships too – enough to pay for living expenses during law school. I took out loans. I invested the loans in a high paying dividend stock and used the dividends during law school. (The stock was ORAN.) The stock was up and down but I sold at a small profit. I put the money into AAPL call options.
AAPL recently spiked so my calls were in the money. I sold, making enough to pay off the remainder of my loans and all my credit cards and non-mortgage debts. I am no genius. Had I waited until today to sell I’d be $30K richer. But I am debt free now and have managed to keep my family fed and happy while I suffered through law school.
I also have not passed the bar exam, despite having gone to a top 15 law school. So I have no law job.