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.
Here are the risks involved with student loans:
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.
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.
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:
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.
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.
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.
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).
