Is it a bad idea to invest a student loan?

Question

My wife is in school and I work full time. My job earns enough to pay for all of our expenses and tuition, with about 60-70% left over for me to invest in retirement and towards buying a house. We are in our mid twenties.

From what I understand of student loans (I never used any), they do not accrue interest while you are a full-time student. Seeing that I already have about 3/4 of my annual gross salary saved, and we do not need any loan money, could I instead take out a loan and use it to increase my investment earning margins during the interest-free grace period? I understand that this is riskier than investing my personal money, because I would be on the hook to pay it back regardless of the stock market's performance.

Are there any laws against doing this? Are there other reasons why this is a very bad idea?

Answer 1

This answer is better served as a comment but I don't have enough rep.

It is not guaranteed that they 'do not accrue interest while you are a full time student'. Some student loans can capitalize the interest - before pursuing leveraged investing, be sure that your student loan is not capitalizing.

https://www.salliemae.com/student-loans/manage-your-private-student-loan/understand-student-loan-payments/learn-about-interest-and-capitalization/

Capitalized interest

Capitalized interest is a second reason your loan may end up costing more than the amount you originally borrowed.

Interest starts to accrue (grow) from the day your loan is disbursed (sent to you or your school). At certain points in time—when your separation or grace period ends, or at the end of forbearance or deferment—your Unpaid Interest may capitalize. That means it is added to your loan’s Current Principal. From that point, your interest will now be calculated on this new amount. That’s capitalized interest."

https://www.navient.com/loan-customers/interest-and-taxes/how-student-loan-interest-works/

Capitalized Interest

If you accrue interest while you are in school – as with Direct Unsubsidized, FFELP Unsubsidized, Direct and FFELP PLUS Loans, and Private Loans – you will have capitalized interest if it is unpaid. Unpaid accrued interest is added to the principal amount of your loan after you leave school and finish any applicable grace period.

Simply put, there will be interest to be paid on both the principal of the loan and on the interest that has already accumulated.

To minimize the effects of the capitalized interest on the amount you will pay overall, you can pay the interest during college instead of waiting until after graduation. That way, you start with the original principal balance (minus any fees) when you begin repayment.

Answer 2

Are there any laws against doing this?

so long as you are truthful in your application for the loan, none that I know of - technically you could use the loan to pay for school and the cash that you would have used instead to invest.

Are there other reasons why this is a very bad idea?

I think you've already identified the biggest one, but here are my reasons:

• Student loans are not discharged in bankruptcy. If your investments tank you are still on the hook for the loans (you already realize this).
• Borrowing investment money eats into your returns. You won't need to make loan payments for a while, but once you do and are paying interest they'll be eating into your investment returns.
• There's no going back. If you decide that you shouldn't have borrowed the money for whatever reason, there's no asset behind the loan to liquidate, unlike a car loan or mortgage. If you pay the loan back with your investments, you risk paying penalties for early withdrawal, taking a loss if the investments are down, etc.

Will you go broke or go to jail? Likely not, but there is significant risk in investing with borrowed money. You might come out ahead, but you might also lose a bundle. If you're willing to take that risk, that's your right, but I would not call it a good idea under any circumstances.

Answer 3

There will be many who will judge your proposal on the idea that subsidized loans should be available to those who need them, and should not be used by others who are simply trying to profit from them. Each school has a pool of money available to offer for subsidized and unsubsidized loans. If they are giving you a subsidized loan, they cannot allocate it to someone else who needs it.

Once you weigh the investment risks, I agree that it is analogous to investing rather than repaying your mortgage quickly. If you understand the risks, there's no reason why you shouldn't consider other options about what to do with the money. I am more risk averse, so I happen to prefer paying down the mortgage quickly after all other investment/savings goals have been met. Where you fit on that continuum will answer the question of whether or not it is a "bad idea".