Taking Student loan I don't need

[HydroJim]

Hello all,

I'm finishing up my freshman year of college and I was offered a $4500 subsidized federal loan for the upcoming year. With the combination of my full tuition scholarship, my room and board stipend, and the pell grant, I have absolutely no need for this money. But, I want to maximize my situation because the loan is interest free until 6 months after graduation.

My current situation:
0 debt
$3500 in savings ($550 inaccessible until I transfer my secured credit card to an unsecured credit card which I'll probably do in the fall.)
$3000 deposited in a Roth IRA last November. Now up to $3171. All in Vanguard VTSMX

Based on my internship income, my unused financial aid money, and other income from gifts, car flipping, etc., I expect to have:
$8500 in my Roth IRA by the end of this year
$7000 in savings at the end of the year

What would you recommend that I do with this loan money? I love the idea of not taking the loan out and being debt free, but I see the opportunity to build my credit, provide myself with an "untouchable unless going to die" emergency fund, and to possibly make some money while doing it.

My first instinct is to take the money and put it in a CD with ally bank. The 5 year option provides a 2% interest rate which is really not horrible considering the current situation. There would of course be risk putting it in the 5 year CD since I'll have to pay it off in 3.5 years. I'd be assuming I'll have enough money in the future. However, the 3 year option provides 1.4% interest. I haven't looked around much beyond Ally but it might also be worth it to just stick it in a savings account and hope that interest rates rise to pre-2008 levels?

My only other real option is to not take the loan. I don't want to put the money in a retirement account because I need to pay it back and any non tax sheltered accounts will affect my financial aid in the future.

[HydroJim]

More info:

Just read that I'll be charged a 1% fee from the disbursement amount right off the bat. It's sounding like less of a good idea.

[frugalnacho]

Take it and park it in VTSMX until 6 months after graduation, then sell the shares and pay it back.  There is a chance it will lose value over the next several years, but that's a risk I would be willing to take.  I am assuming you will be low enough income that you pay taxes on capital gains and dividends.

[gillstone]

I agree with frugalnacho. Plop it in a vanguard brokerage account (not an IRA) and buy up a nice index fund like VTSMX.  The key is you can't touch it until the loan payment is due.  Treat it like its in a glass case that only gets broken open when everything is absolutely engulfed in flames. 

If you are certain you can do that then go ahead and good on you for actually thinking about what you should do with money.

[Dee18]

Read any documents very carefully.  My understanding is that most federally subsidized student loan agreements specifically say the money is being loaned for educational purposes.  If the documents say that and you instead invest the money, you are committing fraud punishable by prison time and penalties.

[Imustacheyouaquestion]

Borrowing money to finance other types of investment is called leverage. It's not a smart move for you. None of your reasons justify taking a loan you don't need (and committing fraud by using federal loans for non-educational expenses):

"Possibly make some money doing it": 2% of $4500 is $90 per year. The expected benefit here doesn't outweigh the risks.

"Opportunity to build my credit": Your secured and unsecured credit cards will build up credit just fine. Taking out loans just for the purpose of building credit is essentially useless.

"Provide myself with an "untouchable unless going to die" emergency fund": If you're young, single, and don't have any major financial liabilities, then $7000 in savings is more than sufficient for an emergency fund. Borrowing money for an e-fund (the point of which is so you can avoid borrowing money in a pinch) doesn't make sense.

[frugalnacho]

Read any documents very carefully.  My understanding is that most federally subsidized student loan agreements specifically say the money is being loaned for educational purposes.  If the documents say that and you instead invest the money, you are committing fraud punishable by prison time and penalties.

Maybe don't send the student loan check directly to vanguard, but cash it then do the vanguard thing on your own.  I don't see how they can possibly prosecute this.  I mean by that logic no one that takes student loans is allowed to participate in a 401k or open an IRA until the loans are repaid? 

[GoldenStache]

Hydro, you forgot to tell us the most important part.. What is the interest rate that you will be charged?  Just because it is a subsidized loan does not mean they will not be charging you interest.

[rubybeth]

DH and I also considered doing something similar. We're paying directly for his tuition, but thought about taking the loan to pay the tuition and then investing our money instead. But those origination fees of 1%, plus him being a grad student and only eligible for unsubsidized loans made it make less sense.

Worst case scenario: you do this, but lose money on the investment before being done with school/grace period, loan comes due, you have no income, and you don't want to cash out all of the investment, so you only cash out the investment monthly in order to make the payment. That doesn't sound too bad, but you could still lose money. Are you tolerant of this risk?

[mtn]

Not the worst idea in the world, but you need to do it right. Put all of your current money in (Insert fund/stocks here) before getting the loan, then use the loan to actually pay for school or school expenses (Housing should work).

[frugalnacho]

Hydro, you forgot to tell us the most important part.. What is the interest rate that you will be charged?  Just because it is a subsidized loan does not mean they will not be charging you interest.

He said it's no interest until 6 months after graduation.

[Gone Fishing]

I wouldn't do it.  3.5 years/$4500 is too short of a time frame and not enough money for this type of deal.  I like15-30 year fixed rate money, $100k+, otherwise known as a mortgage, for something like this.

[okits]

If, taking into account financial aid and taxes, it's worth getting the loan, I'd do something like this:

Invest $4316 in the Ally CD.

Invest the $184 in the index fund of your choice.

In three years $4316 x (1.014 x 1.014 x 1.014) = approx. $4500 principal repayment.

Whatever's in the index fund you keep.

Strictly speaking, you could invest more than $184 in the index and still assure full repayment (unless you believe there's a real chance it could drop to zero.)

This would work a lot better with an interest rate higher than 1.4%, but you get the gist.

Agree you should structure your finances so the actual loan money goes towards actual school expenses. Doesn't mean you can't do this with money you already have.