Is It Illegal To Invest Student Loan Money

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Student loans are distributed for the purpose of covering educational costs for attending college, and they come from both government and private lending organizations. In some cases, students who find themselves with excess money during college choose to invest student loans rather than returning them to the government. While this type of investment is not strictly illegal, it raises numerous ethical issues that result in a legal and moral gray area for aspiring student investors.

Between 1998 and 2000, a college student and inexperienced investor Chris Sacca used his student loans to generate an investment portfolio of more than $12 million, according to Inc.com. Sacca is an extreme example of the growing trend of college students who choose to divert money intended for educational expenses and attempt to generate a return in the stock market. Such a move is risky, but it's not without its benefits, as wise investments can generate revenue that exceeds the interest on private and federal loans.

KEY TAKEAWAYS

Investing student loan money is not illegal.
However, such investing does fall in a legal and moral gray area.
Borrowers of government-subsidized loans could face legal action if they invest the money, which may include repaying subsidized interest.
Private student loans have fewer restrictions and students likely won't face any recourse for investing that money.
A bigger risk, however, might be the inability to generate sufficient return before repayment is due after graduation.

Investing Federal Government Student Loans

The biggest legal consideration when investing student loans is whether the loans are from a private lender or a U.S. Department of Education contracted lender. The Department of Education generally has more strict rules about accepted uses of student loan funds, while private lenders often trade higher interest rates for fewer restrictions.

One of the biggest differences between federal student loans and private loans is that the government subsidizes interest on some student loans as an investment in an educated population. Students who spend their federal loan money on noneducational expenses may not be breaking the law, but they could face legal action from the DOE if their actions are discovered. In some cases, this may include repaying subsidized interest.

Student Loan Amounts

The amount of student loans each student receives is based on a relatively complex formula that takes into account dependent status, parental income, yearly income, residency status and whether the student will be attending full- or part-time. The final figure is known as the cost of attendance, and it generally includes a living allowance for students who are living off-campus.

The living allowance is where the gray area of student loan use begins, as some students choose to invest student loans in excess of attendance costs in the same way that others choose to use them for unrelated living expenses. In cases where institutional scholarships cover the cost of tuition and room and board, students may find themselves with thousands of dollars in unused student loan money to return or invest.

Students who wish to invest student loans while incurring as little risk of legal action as possible should avoid investing government-subsidized loans. Investing the full amount of refunded student loans is also a risky move, and more conservative investors choose to stick to the excess amount allotted for general living expenses. While litigation is a possible risk, the real risk most student loan investors face is not being able to make a return on their investment before payments come due after graduation.

THE ADVISOR INSIGHT

Scott Snider, CPF®, CRPC®
Mellen Money Management LLC,Jacksonville, FL

While not strictly illegal, investing your student loan proceeds means you must beat the interest rate charged on your loan to reap any meaningful benefits. With current loan rates at 5.05% to 7.60%, the range is incredibly wide, while the historical average return of the S&P 500 dating back to 1928 is 10%. Therefore, the risk-reward tradeoff for investing the money of any loans that charge 5% or more is not enough to justify the downside potential. This risk is especially pronounced if you invest the money right before the start of a recession, which could potentially cost you the entire capital plus more. For loans that charge lower interest rates, it is advisable to focus on paying down the debt and then invest other savings instead.

Student loan debt is now one of the largest forms of consumer debt in the country. According to a report fromForbes,45 million people have student loan debt totaling roughly $1.56 trillion in the United States. The average student graduated in 2018 with $29,200 in student loan debt.¹

If you have to repay tens of thousands of dollars in the years to come, wouldn't it be nice to earn credit card rewards along the way? Getting 1% back would help put some money back in your pocket.

Can You Pay Student Loans With a Credit Card?

The U.S. Treasury Department no longer allows student loan payments to be made by credit card. Despite this, some people still try to find ways to transfer their student loan balances to a (cash rewards) credit card.²

But there are a few things you'll need to consider before making that transfer from your student loan lender to your credit card company. Let's take a look at whether you can earn credit card rewards from paying your student loans, how to do it, and whether it is a good idea.

How To Get Out Of Paying Your Student Loans

If you deal with a student loan servicer that accepts credit card payments for no fee or a low fee (or is willing to waive the fee), you might be able to earn significant cash back by using your credit card to make your loan payment. It also depends on whether you are the type of person who always pays your credit card bill in full each month.

Getting the Right Card to Transfer With

First, you'll need to apply and be approved for a credit card with a large sign-up bonus plus ongoing cash rewards. Look for something like $500 cash back after you spend $5,000 (or more) within your first three months of card membership, plus 1% back on all purchases. These cards are usually reserved for people with very good to excellent credit.

Remember, not all credit cards are created equally—meaning, not all cards allow you to transfer your loan balance. So, you'll want to make sure you have the right card. According to WalletHub, the following companies offer students the option to transfer their student loan balance over to their credit cards: Bank of America, Barclay's, Capital One, CIT, Discover, Pentagon Federal Credit Union (PenFed), USAA, U.S. Bank, Wells Fargo, and SunTrust Bank.³

Set aside the cash to pay off your pending credit card charge, so you don't end up trading low-interest debt for high-interest debt.

As of 2020, SunTrust's Prime Rewards card is among the best balance transfer cards. Additionally, Bank of America's Travel Rewards card and Capital One's Quicksilver Cash Rewards card are among the best rewards cards available as of 2020. This is the card you'll use to make a large, one-time extra payment on your student loan.

Then, before making the payment, make sure your credit card issuer won't characterize the transaction as a cash advance—and get that confirmation in writing. Also, let your credit card issuer know ahead of time that you're going to be making a large transaction so it won't be declined or flagged as fraudulent.

KEY TAKEAWAYS

According to the U.S. Treasury Department, borrowers may not use credit cards to pay their student loans.
It may be possible to transfer student loan balances to a credit card to pay them off. Not all credit cards will allow these types of transfers, but some companies do allow them.
If you're having trouble making your student loan payments, transferring the balance of the loan onto a credit card is not recommended.
Make sure your credit card company won't note your payoff transaction as a cash advance.

What Happens After You Make a Payment?

After making the payment, keep an eye on your credit card account to make sure the transaction posts as a purchase, not a cash advance. If all goes well, you'll meet the requirements to earn the sign-up bonus, plus earn 1% back. You'll then want to pay your credit card bill in full and on time to avoid incurring interest or late fees.

With this strategy, you'll accomplish three financial goals at once: taking a chunk out of your student loan principal balance, saving all the interest you would have paid on that principal over the years, and earning significant credit card rewards.

And if you're lucky enough to have a student loan servicer that accepts credit card payments for any amount with no fee, there's no reason not to pay your student loan bill with your credit card every month, as long as you're not carrying a credit card balance.

Read the Fine Print

Make sure you know your limitations as well as the terms and conditions of your card before you make the transfer. First, you'll want to make sure you can transfer only as much as you can afford to pay back to the credit card company. Don't get overindulgent just to get the points or the rewards if you can't at least meet the minimum payment requirements of your credit card.

Secondly, if you're doing a balance transfer, know that these transactions may come with a higher interest rate. So if you can't make the full payment at the end of the statement month, you may be paying a higher interest rate than a regular purchase transaction. If it's a new card, you may be able to benefit from low- or no-fee balance transfers for the first six to 12 months.

How to Make Your Payment

Can't do a balance transfer? Contact your credit card company for a convenience check. You'll write this the same way you write a check from your bank account, except it's drawn on your credit card. But keep in mind, convenience checks can also come with a high-interest rate, so you'll want to know what rate and fees apply.

You can also try making payments through third-party processors like PayPal, Stripe, Plastiq, or Square. These systems will charge your credit card directly and then send a check or a wire payment to your student loan company. But beware: You may be charged a fee for using their services. Some of them charge a percentage of the payment balance, so you'll want to be sure how much more you'll be paying. Some of these companies may offer incentives and promotions or lower fees.

Know What You're Getting Into

If you're someone who typically carries a credit card balance, it doesn't make sense to make your student loan payments with your credit card. Student loan interest rates are generally lower than credit card interest rates, so if you're having trouble making your student loan payments on time, it may be cheaper to incur a late payment fee to the student loan company instead of accruing interest on a credit card.

You'll also lose any protections that cover student loan debt. Unlike credit cards, there are certain rights you have as a student loan borrower. Consider some of the options you have as a student loan borrower such as income-based repayment plans, payment deferments, or even forbearance. These options allow you to stop making payments while interest still accrues on the loan. These options are not available to credit cardholders.

If you're having trouble making your student loan payments, your best option is to look into refinancing or changing the repayment plan on your student loans.

Will It Hurt Your Credit Score?

Paying off a large chunk of your student loan with a new credit card can actually help your credit score in several ways. Applying for a new credit card will temporarily ding your credit score. However, the increase in your total available credit from the new card's credit line can help boost your score. Paying down the balance on your student loan can also bump up your credit score.⁴

Charging a large payment that uses up more than 30% of your new card's available credit can hurt your credit score, but if you pay off the charge before your statement is issued, that large balance won't be reported to the credit bureau and won't hurt your score. Your on-time bill payment will help your score.⁵

These are general guidelines about how the credit bureaus say different actions affect borrowers' credit scores. FICO cautions that different actions will affect different consumers' scores in different ways, depending on the total picture of their credit profile.⁶

The Bottom Line

Many student loan providers won't let you pay your student loan with a credit card, may charge a fee for doing so, or will limit how much you can charge. These rules are in place to save lenders money on credit card processing fees and to keep consumers from turning relatively low-interest student loan debt into higher-interest credit card debt.

But if you have excellent credit-card habits, a chunk of extra cash to pay down your student loan, a great rewards credit card, and a student-loan lender that will accept credit card payments without tacking on a fee, you can come out ahead by making student loan payments with your credit card.