Imagine this scenario: You are a freshman in college and you were fortunate enough, through hard work, to apply for enough scholarships (free money) to pay for your entire first year of college. Your tuition, room and board, books, and even your laptop is covered.
Your first week on campus you start hearing some of your new friends talk about their refund checks that they have received from the financial aid office. You are intrigued, so you inquire a little deeper. Your friends had taken out student loans that covered more than their actual tuition and fees, which generated a credit balance to be sent back to them as a “refund” check.
Now you are very intrigued, so you approach the financial aid office and inquire about a student loan. Sure enough, because you have room left in your cost of attendance, you can take out up to $2750 in a Subsidized Stafford Loan for the semester at a 3.4% interest rate. The payments AND interest are deferred until 6 months after you graduate.
“FREE MONEY!!” You think gleefully as you sign the request form. A month later, you receive a check in the mail for $2700 (after origination fees) of your “FREE” student loan refund check.
Back to reality…..
This scenario happens millions of times every semester at colleges all across the country. Students take out student loans in excess of their required fees, and wind up with large credit balances which are given back to them.
Many of these credit balances are intended to pay for off-campus room and board, transportation and personal expenses, but let’s be real. A 19 year old college student will not have a clue what to do with the largest check he has ever received in his life!
So the big question is “What could you do with this money?”
Can you invest your Stafford loan with deferred payments and a killer interest rate?
The answer is NO!
It’s illegal, and it’s just plain dumb!
Ok, that might have been a little harsh, but it’s the truth. First off, it is illegal. The Department of Education states that a credit balance can only be used to pay for “educational expenses included in the cost of attendance”.
Cost of Attendance = tuition and fees, room and board, transportation, personal expenses, and books and supplies.
Investing this money, while a very ingenious and industrious idea, does not fall into any of these categories.
It also is just not a smart idea.
Investing on a margin, or borrowed money, is always a risky move. Where would you invest? You already lose about 1% in origination fees upon disbursement, so your investment yield would have to exceed that.
If you invest in the stock market, your investments are not guaranteed, so you run the risk of losing money and still owing that money back to the Feds.
If you invest in a stable money market fund or high interest savings account you will only receive 1.5% at the most, back on your investment. This would barely cover the cost of your origination fees.
So non guaranteed investments are too risky, and stable investments will not earn you any profit. I really do not see any upside to this. Besides, short term investing is for the professionals on Wall Street, and you see where that has gotten them recently!
Bottom line, you will not get anywhere by investing your student loan refund money.
However, I will say that this is an incredibly enticing idea, and anyone who is ingenious enough to actually consider doing this as a college student, has a serious head on their shoulders.
I would take this creative genius and apply it towards creating a sustainable business venture while in college. You could:
- Buy and sell textbooks using arbitrage
- Become a freelance writer
- Create a moving company with your friends and charge students to move them in and out of their dorm rooms
- Start a travel agent service to help students book travel during spring break and winter break
- Teach a course on positive studying habits
The opportunities are endless.
The Best Alternative
So if you should not invest a student loan refund, what should you do with it?
Give it back to your school and cancel that portion of your student loan.
A student loan has to be repaid. Your repayment may not start until after you graduate, but it will start, and it will be required.
The nasty little thing about student loans from the Federal Government is that they cannot be discharged in bankrupty, you cannot have them cancelled, and if you default, they will garnish your wages and take your tax returns until they are satisfied.
So, I say that to say, avoid student loans at all cost. Do not keep a credit balance refund if you do not absolutely need it for living expenses.
March your check back to your financial aid office, and ask them to cancel that portion of your student loan. If they won’t do it (they should) you can always cash the check and make a payment directly to your loan servicer.
Doing this will save you future debt, and the struggle of having to budget in student loan payments for the next 10 – 30 years!