Free money? Hidden deathtrap?

April 26, 2010 10:26 AM

Should I take a subsidized Stafford Loan if I don't need it?

[FinancialAidFilter] I'm starting a graduate program, and FAFSA calculated my need in such a way that I'm eligible for an $8500 subsidized Stafford Loan for my first year.

The thing is, I don't need a loan. While everything I put on FAFSA is correct, I've got enough savings and income (I have a full-time job) to cover all my expenses without going into debt.

I understand that there's a 4% origination fee on these loans, but is there any compelling reason I shouldn't take it out, invest the money (I'm assuming I can put it to work for at least 4% in the 21 months I'll be in school) and then pay it back immediately on graduation day? Is there some gotcha here, or is it free money that I should jump for?

posted by zvs to work & money (30 answers total)

Ethically, you should leave that money available for those who need it. However, it would make financial sense for you to take this money out if you think you would be able to make back the 4% (not as easy as you might expect) or if you think you would be able to put that money to good use if you had it (and still pay it back right after graduation).
posted by Night_owl at 10:34 AM on April 26, 2010

You're not supposed to invest the money. I don't know how they'd find out, but that's against the terms of borrowing the money. If they find out, I think you might end up serving prison time. Seeing as you linked your website here, I advise against thinking about it.

Now, if you want to invest your own savings and use the loan to directly pay your tuition (which I think they disburse directly to the school anyway), that's pretty much the same thing only you're not using the Federal loan for it technically.
posted by anniecat at 10:36 AM on April 26, 2010

Do you have any other debt? Older student loans, credit cards, car loans? The stafford loan is a good way to pay any of those off and stop yourself from accruing any more interest, which is what I did. The federal government gives you benefits (like loan forgiveness after 10 years if you go into a public service job) and better payment terms than just about any other lender.

I've known people who did just what you did, or who used that money as a cushion for emergencies and paid it back just after graduation, and it worked out fine for them.
posted by PhoBWanKenobi at 10:39 AM on April 26, 2010

I'm assuming I can put it to work for at least 4% in the 21 months I'll be in school

That's unlikely to happen. Having a paid-off loan on your credit report isn't a bad thing, however.
posted by spaltavian at 10:40 AM on April 26, 2010

anniecat: Yes, investing my excess savings is what I mean, of course. I've got more than $8500 in tuition, so all the loan money would go to that.
posted by zvs at 10:41 AM on April 26, 2010

PhoBWanKenobi: I am debt free. I use my credit cards for rewards and pay them off monthly.
posted by zvs at 10:42 AM on April 26, 2010

Good luck finding a way to earn 4% interest that's not full of down size risk. Most everything I've seen has been 1-2% (CDs, Bonds, Savings Accts).

That said, I think the answer boils down to how much personal discipline you have. If you're pretty disciplined then I would say go ahead and get the loan and use the extra money as a safety net in case something really unexpected comes up. The goal would be to pay it all back as soon as you graduate. You will still end up slightly worse off than if you didn't take the loan (the origination fees), but you'll have a good financial safety cushion.
However, if you're not sure about your discipline, or if you really want to stay financially ahead and are willing to deal with any financial issues if they arise, then I would skip the loan.

On preview: I'm not sure that it's an ethical question since there doesn't seem to be a single "pot" of Stafford Loan money, so you're not harming somebody else by taking the money.

On double preview; There isn't an issue with saving the loan money in an interest bearing account until you use it. There would be a potential problem if your loan exceeded your education costs.
posted by forforf at 10:44 AM on April 26, 2010 [1 favorite]

You have enough for the entire term of your education, or just this first year? If it's the former, I would say pass it up. It's true that these are pretty cheap loans and odds are that you *could* reinvest it and make a little money but obviously you're taking a risk, and to me the realistic realistic pay out seems pretty slim for the risk.

But then there's the issue that this is really not what these loans are for. I finished school with a butt load of Stafford Loan debt and to my knowledge, the only thing I had to prove was that I paid my school tuition. No one ever asked me for text book receipts, canceled rent checks, etc. Unless they changed the way these things are regulated, I think you could get away with what you're talking about doing. In fact, some people at my school day traded their student loans into a tidy profit (this was the 90s). Me, I just wanted an education.

I know you are thinking you won't have a heavy debt burden when you're done but it should be factored in that finishing school and having to find a job right away because you've got to start paying off your loans sucks and despite these being cheap loans, it does limit your choices out of school. Just on the off chance that you blow it.

But if you're not quite sure you really have enough money to stretch all the way? Or if the extra money means you could afford to eat better than ramen noodles and popcorn for two years, or allow you spend a week in Hawaii half way through the program. Then I'd probably do it. You are likely allowed only $8500 per year. If you find yourself needing to borrow $10,000 that second year, the $1500 balance is going to be an expensive private loan and you're better off maximizing your Stafford debt.
posted by Slarty Bartfast at 10:47 AM on April 26, 2010

Ethically, you should leave that money available for those who need it.

Forget that. You are eligible for it so if you want it, you can take it. I wish I had. I foolishly turned down subsidized loans in the past and it just went to other people. Pay off debts, park it in CDs to have a nice cushion, build your credit later when you pay it off.
posted by codswallop at 10:48 AM on April 26, 2010

These are useful answers.

4% interest over 21 months is 2.26% annual yield. A good CD right now is 1.54%, so 2.26% is within reach for low-risk investments; sufficiently low-risk that if I end up down $100 over the lifetime of the loan, I won't be crying in my beer or anything.

And the loan definitely doesn't exceed my costs.
posted by zvs at 10:49 AM on April 26, 2010

Do you have any other debt? Older student loans, credit cards, car loans? The stafford loan is a good way to pay any of those off and stop yourself from accruing any more interest, which is what I did.

PhoBWanKenobi, are you sure this doesn't fall under misuse, especially the paying off credit cards and car loans business? Someone might report you if they caught wind that you did this and OIG will launch an investigation. It's fairly easy to report and you can't say you didn't know because of the entrance loan counseling which is pretty explicit in saying you can't just use the money however you want:

What can I use my federal student loan money for?
You may use the money you receive only to pay for education expenses at the school that awarded your loan. Education expenses include school charges such as tuition; room and board; fees; books; supplies; equipment; dependent childcare expenses; transportation; and rental or purchase of a personal computer.
posted by anniecat at 10:57 AM on April 26, 2010

PhoBWanKenobi, are you sure this doesn't fall under misuse, especially the paying off credit cards and car loans business? Someone might report you if they caught wind that you did this and OIG will launch an investigation. It's fairly easy to report and you can't say you didn't know because of the entrance loan counseling which is pretty explicit in saying you can't just use the money however you want:

I technically was using my savings to pay off older, higher interest rate student loans--as with everyone else, my loan monies were deposited to the school first.

Maybe that was illegal or immoral, though. It was fairly common practice when I was in graduate school, as was, in more than one case, buying lots of weird stuff on ebay.
posted by PhoBWanKenobi at 11:05 AM on April 26, 2010 [1 favorite]

I technically was using my savings to pay off older, higher interest rate student loans--as with everyone else, my loan monies were deposited to the school first.

I don't think they care if it's immoral or common, it's that it's illegal. I'm not sure the OIG would care that you were using it to pay off older student loans. They do investigate and prosecute even if this has already happened or happened years ago, and it really is not wise since they can subpoena your bank statements from years ago even. It is a traceable crime.

Federal student loans are disbursed first to the financial aid office, and once loan proceeds have been applied to any mandatory expenses, any remaining funds are disbursed to students. While no one can dictate how those loan proceeds are used, they're usually a very small portion (if any exist at all) of the original loan amount. No federal student loan is simply cut as a check to a student because of concerns about fraud and misuse.

If you suspect that funding is being misused, you can contact the school's financial aid officer. If you suspect that fraud is being committed, you are encouraged to report fraud to the Department of Education's Office of the Inspector General. The OIG takes all claims of fraud, waste, and abuse very seriously and will prosecute to the maximum extent permitted by law.

Department of Education OIG:
http://www.ed.gov/about/offices/list/oig/index.html

Best wishes,

Christopher S. Penn
Financial aid expert and managing editor, FAFSA Online
http://www.FAFSAonline.com
posted by anniecat at 11:13 AM on April 26, 2010

I'm not Christopher S. Penn, btw. He posted that here.
posted by anniecat at 11:16 AM on April 26, 2010

I would absolutely save it as a cushion. At this point (sixth year as an undergrad who planned to be done in four years) I sure wish I'd saved more of my aid refund checks.
My roommate saved her checks and used the refunds to pay for her entire fourth year of college. She's not debt free, but she owes a whole lot less than I do. If something catastrophic had happened to her, she would have had her savings to fall back on. Brilliant if you ask me.
posted by Iggley at 11:17 AM on April 26, 2010

The scenario you're discussing isn't fraud. It's not like these are marked dollars. The loan is paid first to the university, then any leftover $X is given to you. As long as you have X in qualified educational expenses (which includes such broad categories as 'room and board'), that's "how you spent that money". If you then have $Y more saved than you would have, how you spend it is your business, as you've discharged your responsibilities under the loan. It's fungible numbers in a bank account.

What I'm really looking for here is "No, because if you try to repay early, hidden fees kick in" or something. I haven't heard this yet, so I'm hoping there's no such case.
posted by zvs at 11:22 AM on April 26, 2010

(Which is to say, I have no plans of committing fraud -- or managing my money so poorly that I end up in debt.)
posted by zvs at 11:23 AM on April 26, 2010

What can I use my federal student loan money for?
You may use the money you receive only to pay for education expenses at the school that awarded your loan. Education expenses include school charges such as tuition; room and board; fees; books; supplies; equipment; dependent childcare expenses; transportation; and rental or purchase of a personal computer.

This seems to cover a lot of ground. Transportation could mean anything from gas, car insurance, maintenance costs, repairs etc. That plus rent alone could add up to $8500 per year.

I suppose they could be getting real specific and say that it only covers room and board if you're living on campus and you pay the university, but how would they say that you pay transportation costs directly to the university?
posted by Iggley at 11:34 AM on April 26, 2010

ZVS, sorry that was a derail. I was warning PhoBWanKenobi that she should rethink what she wrote, lest she find that someone is reporting her to the OIG. I understand how they're disbursed, but it's pretty explicit what that money is supposed to be used for, and if someone felt like reporting you (especially if you used it to pay off credit cards or car loans), it's really easy to do so and have an investigation done, no matter how you want to argue it. Since you already have the money for tuition (and you reported it on your FAFSA) and they're still offering you the loan and you're essentially investing YOUR money and NOT the loan money technically, and you plan on paying it back rather than defaulting, then you can do whatever you want with it. But I would be careful posting that stuff on here and not anonymizing your question, because someone who feels like they have to report suspected fraud may just go ahead and do so. Though their division that actively prosecutes federal loan fraud has some bigger fish to fry at the moment. But they do look into these things.
posted by anniecat at 11:41 AM on April 26, 2010

Iggley, for Federal Direct Loans, this is an example (I'm sure the Stafford doesn't have different terms):

The following expenses cannot be covered by education loans:


Car insurance

Car payments and repairs

Credit card debt

Expenses related to your job search

Fall, winter and spring break travel or trips

Furniture

Moving expenses

Personal gifts

Security deposits, first and last months' rent


There was a related thread addressing the transportation issue on this previously.
posted by anniecat at 11:49 AM on April 26, 2010 [2 favorites]

How do you propose to garner 4% returns in a situation? This question is purely contingent upon your risk tolerance in today's marketplace.
posted by Hurst at 11:52 AM on April 26, 2010

Hurst: 2.26% returns, as above, which is barely above the current yield on an 18-month CD. I understand the risk tolerance question of trying to beat 4% in 21 months; that's not really what I'm asking. I won't be in the poorhouse if the investment calculus doesn't work out in my favor. I'm really just looking for hidden pitfalls.
posted by zvs at 11:59 AM on April 26, 2010

iggley, the FAFSA asks whether you're going to live on-campus or off. It doesn't affect the amount of the loan, and I have been advised by campus officials that off-campus rent is an allowable expenditure under the terms of the loan.
posted by catlet at 12:13 PM on April 26, 2010

I think investing this money would be a bad idea, but I'd still seriously think about taking out the loan and just chucking it in a savings account.

My thinking here is that you're going to be spending almost two years with no real income. If you take the loan and wind up not needing it, even at CD rates you're talking about breaking even at worst. But if, for example, your car breaks down, you need surgery, you have to fly somewhere for a funeral, etc., you can use the loan money for tuition and your own money for repairs. Money is fungible that way.

Here's how I'd break it down:
- The worst case scenario is that those expenses do come up and you didn't take out the loan. Then you'd be in a tight spot, as you could face a liquidity crisis which could be difficult to remedy without using credit cards.

- Next is if you take out the loan and still have the expenses. You'd have no liquidity problem because the money would already be on hand, and you'd be left with a relatively cheap loan to pay off, over a decade if you need to.

- The best is if you take the loan, don't need the money, pay it off upon graduation, and either break even or make a few bucks. I don't see anything wrong with this, as you are incurring educational expenses and could well need access to those monies.

I would not seriously invest this with the hopes of making any serious kind of money. AmEx Online Banking currently has an FDIC-insured savings account at 1.3%APY, which isn't terrible. The advantage of that over a CD is that you have access to the money at a moment's notice with no penalty.

One last point of interest: you actually have 27 months, not 21, of free interest. There's a six-month grace period after graduation before your first payment is due and the government stops subsidizing your interest. Makes that 4% even easier to get.
posted by valkyryn at 12:44 PM on April 26, 2010 [1 favorite]

Stafford Loan Discounts

Many many banks waive the origination fee, for example Wells Fargo, so it really is a 0% loan. It's un-American not to take free money.
posted by paperzach at 1:11 PM on April 26, 2010 [1 favorite]

Upon further research, that link is not entirely up to date, Wells Fargo is charging 1.5% these days. Check the banks themselves, you may be able to find a 0% place... in any case, it won't be tough to make more than 1.5% over two years.
posted by paperzach at 1:27 PM on April 26, 2010

What I'm really looking for here is "No, because if you try to repay early, hidden fees kick in" or something. I haven't heard this yet, so I'm hoping there's no such case.

I can speak with confidence about this. The federal government is all about you paying off loans early. There are no early repayment fees.
posted by PhoBWanKenobi at 1:30 PM on April 26, 2010

Speaking as someone who took the loans, I wouldn't do it again. If I had not had the cushion, I would have spent more responsibly. Psychologically, once it's in a bank, it's yours. So even if you have this plan to be responsible with the money, crises will arise and you will want to spend it. Better to be a little strapped without this loan taken out in your name.
posted by pickypicky at 2:39 PM on April 26, 2010

My advice is, of course, predicated on having the self discipline to avoid the sorts of traps of which pickypicky speaks.
posted by valkyryn at 4:42 PM on April 26, 2010

If this Stafford loan is for Fall 2010, it will a Federal Direct Loan, straight from the US Department of Education (After July 1 2010, they all will be).
If you are a grad student, there is a 1.0% origination fee with a 0.5% upfront rebate, resulting in a half-of-a-percent origination fee. (The rebate is contingent on making your first 12 payments on time. If you don't, they'll tack it back on).

Interest rate will be fixed at 6.8%, but since it is subsidized, it will not accrue while you are enrolled in school.
posted by battleshipkropotkin at 1:53 PM on April 27, 2010