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If I have money in various mutual funds / 529s / other college savings plans, would it be wise to take out interest-free loans for the duration of my education (in order to allow the money saved to continue generating interest, and also to work on a credit score) and pay the loans off with the money immediately after they start generating interest, or should I simply use the money I have saved directly?

I am an undergraduate student soon graduating high school.

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    Note that student loans are not a qualified expense for a 529. – user48207 Apr 4 '17 at 14:00
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    @sgroves: The loan is free and the cash accrues interest. – Mooing Duck Apr 5 '17 at 0:15
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    @sgroves: I can't think of a single not to do this actually, at least beside it being lots of paperwork (or unless you lack self-control on what you spend)... – Mehrdad Apr 5 '17 at 6:04
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    Having cash is useful. It means that you may not have to take out a loan for something else later. For example: I have cheap and safe (non-us) student debt, which I could pay off early. But I won't, because I'd rather have debt and a house deposit. I don't know enough about US debt to answer this question though. – Nathan Cooper Apr 5 '17 at 10:09
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    @sgroves The loan is not free. At best, the interest is subsidized while you are in school. As soon as you graduate, you start accruing interest. Now if you've been conservative and kept the cash aside (not the 529s, as explained below), then you might come out ahead. Or you might decide "I need a car" and keep the loans around a bit. Or you might think "I could buy a house, and the student loan will be cheaper". The next thing you know the loans are still around and you don't have the cash to pay them off. That's what I did so I know it can happen. – D Stanley Apr 5 '17 at 13:22
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Here are the risks involved with student loans:

  • They are very difficult to get discharged in a bankruptcy - the only way you can get rid of them is through death or disability (there are forgiveness programs but they are designed for people that can't pay them back, which means you shouldn't have taken a loan in the first place)
  • They encourage you to spend more - if you aren't paying anything until you graduate, then it "feels like" free money - you aren't encouraged to reduce costs. You might buy new books, take more classes, new school clothes, buy more expensive meal plans, etc. If you're paying cash you "feel the pain" of costs and are encouraged to reduce them (or get a part-time job to generate some income). Or worst-case - you go to a college that you can't afford. There are studies that show that, all else being equal, the college you attend does not significantly affect your salary. Your abilities, work ethic, and career choice are much more significant.
  • There's no "asset" to return to satisfy the debt - unlike a car loan or a mortgage where you can turn i the asset to satisfy most (or all) of the debt.

So - what happens if you decide (or are forced) not to finish school (50% of students don't)? You have no degree to boost income, but still have the debt.

What happens when you graduate and want to use that saved cash buy a house, car, etc., and treat the student loans as a monthly bill? The next thing you know you're loan-poor and are struggling to make your monthly payments just like most other "normal" people.

You aren't going to earn significant interest on your cash while you're in college (and it will not outpace inflation), and there's significant risk of your college savings losing money if they're not in risk-free investments, so it would NOT be wise to take out student loans when you have the means to cash-flow it.

Also, student loans generally charge a roughly 1% fee, so that actually negates the interest you earn in your savings account.

Plus you already have money in a 529 plan that is meant for college expenses (and cannot be used to pay student loans) - use that money for what it's for.

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    Wish I could upvote this more than once. Do not go into debt. Do not go into debt. Do not go into debt. – Kevin Apr 4 '17 at 22:16
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    @kevin If you have 100,000$ in cash and 80,000$ of interest-free debt, you are not in net debt. Your situation is strictly better than someone who has 20,000$ in cash. – Yakk Apr 5 '17 at 5:41
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    @Yakk Except he doesn't have it in cash, he has invested in instruments that could lose money. The small amount he might earn over four years, especially the next four years, is not, in my opinion, worth it for the reasons D Stanley listed. – Kevin Apr 5 '17 at 12:35
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    @Yakk Student loans are not interest-free. The interest is subsidized (paid by the government) while you're in school. As soon as you quit school, you start accruing the interest. That's the problem - it "feels" like free money. And the three risks I mention in my answer still apply whether interest accrues or not. – D Stanley Apr 5 '17 at 13:25
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    @xiaomy The risks are not financial, they are behavioral. You need an incredible amount of self-control to leave $100k sitting in a bank account. That's a lot to ask of a college student that is bombarded with pressure to buy a better car, new books, social activities, or a house. Plus student loans to have fees around 1%, which cuts your "risk-free" return in half. – D Stanley Apr 5 '17 at 15:30
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Plus you already have money in a 529 plan that is meant for college expenses (and cannot be used to pay student loans) - use that money for what it's for.

I disagree with @DStanley, as a current college student I would say to take out loans.
Most of the time I am against loans though.

So WHY?

There are very few times you will receive loans at 0% interest (for 4+ years). You have money saved currently, but you do not know what the future entails. If you expend all of your money on tuition and your car breaks down, what do you do? You can not used student loans to pay for your broken car.

Student loans, as long as they are subsidized, serve as a wonderful risk buffer. You can pay off your loans with summer internships and retain the initial cash you had for additional activities that make college enjoyable, i.e - Fraternity/ Sorority, clubs, dinners, and social nights.

Another benefit to taking these loans would assist in building credit, with an additional caveat being to get a credit card. In general, debt/loans/credit cards are non-beneficial. But, you have to establish debt to allow others to know that you can repay. Establishing this credit rating earlier than later is critical to cheaper interest rates on (say) a mortgage.


Use your 529 (to the extent you can per year) and use other savings to pay off the loans your senior year or when you graduate.

You have made it through, you have watched your expenses, and you can pay your debt. Finish It. If you do it right, you will not have loans when you graduate, you will have a stunning credit rating, and you will have enjoyed college to its fullest potential (remember, you only really go through it once.)

But this is contingent on:

  1. Finishing College
  2. Trying to graduate as soon as possible (or say Doctorates in 6 years instead of 8)
  3. Watching what you are spending on a weekly basis.
  4. Finding alternative sources of income to pay for college (scholarships or company sponsorship)

Good luck,

EDIT: I did not realize the implication of this penalty which made me edit the line above to include: (to the extent you can per year)

For now, student loan repayment isn't considered a qualified educational expense. This means that if you withdraw from a 529 to pay your debts, you may be subject to income taxes and penalties.Source

Furthermore,

Currently, taxpayers who use 529 plan money for anything other than qualified education expenses are subject to a 10% federal tax penalty. Source

My advice with this new knowledge, save your 529 if you plan on continuing higher education at a more prestigious school. If you do not, use it later in your undergraduate years.

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    "as a current college student" - when I was a college student I probably would have said the same thing. As a graduate that had to pay back student loans for several years (even with a good income) I stand by my opinion. I suspect if you found a student that didn't graduate you'd get a different opinion as well. – D Stanley Apr 4 '17 at 17:19
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    You currently can't use a 529 to pay off student loans without a 10% penalty. There is legislation that would allow that, but I would argue that you shouldn't have leftover 529 money AND student loan debt. – D Stanley Apr 4 '17 at 17:22
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    Liam, I am the DV. The 529 issue is critical. Not just penalty, but tax on gains. 529 money really needs to come out during the same year as the college is sending your tax receipt for tuition. OP doesn't state the mix, and parts of your answer may apply, but the advice doesn't hold for 529 or College saving account (formerly the Education IRA). – JoeTaxpayer Apr 4 '17 at 18:57
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    " You can pay off your loans with summer internships and retain the initial cash you had for additional activities that make college enjoyable" The first half of that hasn't been possible for a very long time, and the second half is terrible advice. – Mooing Duck Apr 5 '17 at 0:18
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    "You can pay off your loans with summer internships" - If this were true, hardly anyone would need student loans. People work full-time jobs for years and years after graduating to pay off student loans. – Dan C Apr 5 '17 at 3:21
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Place your savings into safe interest-bearing accounts.

Take out the loans. Keep constant track of your net worth.

Having 100,000$ and 80,000$ in interest free debt is better than having 20,000$. You can always convert money + debt into less money and less debt, but you cannot always convert less money and less debt into more money and more debt.

Now, there are risks; that is why you want an interest-bearing account to place your savings in to offset the debt. This minimizes the risk. It also reduces the return.

It is arguable that you should be at your most financially risky at a young age. I'd argue that your future earnings are your by far largest asset at this point, and as a high school student going into college those future earnings have extremely high variability.

Your financial situation is extremely unpredictable; being conservative about your high-leverage student-loan + education investments is probably justified. The fact you can manage arbitrage here means you should; and if you are careful, you can eliminate risk and get almost risk-free profit from the maneuver.

If your money is in less than perfectly safe accounts, you are now doing leveraged investing and magnifying the risk and return of said investments.

If your money must be spent on college or you'll be financially punished, then you may want to consider pulling it out before the last possible legal point just in case something goes wrong.

Apparently 529 plans may not treat "paying off student loans" as a valid way to spend the money. You may need to talk to a lawyer or accountant about the legality of using these plans to pay off student loans, and the tax/penalties involved.

  • That last paragraph is extremely important... – Floris Apr 5 '17 at 21:02
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It's not a question with a single right answer. Other answers have addressed some aspects, my case may provide some guidance as to one way of looking at some of the issues.

When I had student loans, the interest rate was RPI¹ and I could get more than that as the return on a savings account. At the time I could get a whole year's worth of loan at the start of the year, save it, and draw from the savings, partly because I had a little working capital saved already. Importantly in my case, the loans were use-it-or-lose-it: if I didn't take the loan out by about halfway through each academic year, it was no longer available to me.

The difference in interest rates was probably similar to what you can get with a careful choice of savings account and 0% on the loan (I did this in the 90s when interest rates were higher).

Over a four year degree the interest I earned this way added up to no more than about £100, which went someway towards offsetting the fact I would be paying interest after graduation. If you can clear the loan before you pay any interest it would give you a return, but a small one that could easily be eroded by rate changes or errors on your part (like not keeping on top of the paperwork). It still may be beneficial to take out the loans depending on your capital needs -- in my case it made buying a house after graduating much easier, as we still had money for the deposit (downpayment) and student loan rates were much lower than mortgage rates (100% mortgages were also available then, but expensive).


¹ RPI stands for retail price index, a measure of inflation.

  • "The interest rate was RPI". Sorry, what does that acronym mean? – JoeTaxpayer Apr 6 '17 at 0:08
  • @JoeTaxpayer, sorry I assumed that was international but it must be a UK term. It stands for retail price index, which is an inflation measure. – Chris H Apr 6 '17 at 5:42
  • Thanks, Chris. For our general rate of inflation, we use CPI, consumer price index. But our loans, if variable, tend to be tied to government paper (Treasury Bill) or "Prime Rate", a bank-generated rate used for loans. It's a big world, I'm in my 50's and still learning. – JoeTaxpayer Apr 6 '17 at 9:26
  • @JoeTaxpayer we use CPI quite a lot too. Anyway, now I'm on dekstop I'll edit in a link/explanation. – Chris H Apr 6 '17 at 9:31
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I think the answer to this question depends on how much you trust yourself. Most people are wonderful at deceiving themselves. I'd personally not trust myself; I'll use Liam's points for the pitfalls some people get into.

You can pay off your loans with summer internships and retain the initial cash you had for additional activities that make college enjoyable, i.e - Fraternity/ Sorority, clubs, dinners, and social nights.

This is actually the risk I've seen many people do. They'll blow their money in one semester under the assumption that 'they'll just earn more in Summer and keep it for expenses or the future."

Another benefit to taking these loans would assist in building credit,

No Credit (in the USA) is actually a good standing. Many sensible banks or credit unions will happily give people with No Credit a loan. This makes intuitive sense if you think about it. Imagine two people with the same income. One owes money regularly to multiple sources and the other has no debt obligations. Which one are you loaning money to?

Simplifying things a lot: Great Credit is best, followed by No Credit, then Good Credit, and then Bad Credit. The advantage of Great Credit over No Credit is simply that some institutions in some sectors don't have the policies in place to process No Credit people (No Credit people plan to not apply for credit often, for self-explanatory reasons, so this is a mote point).

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    No Credit is a question mark and risk managers don't like variables they can't measure. You can't assess the habits of the person because there are none. Great credit has all those and they look shiny. Don't understate. – Mindwin Apr 4 '17 at 19:52
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    Not my specific field, but I would flip no credit and good credit in terms of how attractive they are to lenders. No credit people can typically find someone to work with them on small ticket items, but it is much more difficult for larger things like mortgages. One of the key things the lenders look for is a consistent history of on time payments. Why should they take a six figure risk on someone that has never had to commit to an ongoing payment schedule? – Rozwel Apr 4 '17 at 20:43
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    -1. Even if no credit doesn't hurt, delaying credit building means a shorter credit history and a lower score. So if you are going to borrow money at some point down the road, why not build a history early on? – xiaomy Apr 5 '17 at 1:12
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    No credit record is awful. The older you get, the worse it is. Getting anything besides small loans is pretty difficult without actual history of repaying loans. – trognanders Apr 5 '17 at 9:07
  • @Rozwel Why would a person with no history of being in debt be riskier than someone with a long history of being in debt? Someone with No Credit can (should) be able to provide history of payment, tracks of rent receipts, etc... – Lan Apr 5 '17 at 15:58

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