I recently came across an interesting thread on a forum concerning the usage of student loans. These people had basically invented a fairly brilliant, if somewhat ethically-grey strategy for maximizing returns when they used a student loan to invest. These individuals (they obviously posted anonymously) were the product of “old money” and they were law students. They obviously thought about money and how to use it to their advantage, much differently than the majority of people. Their parents had retired from their main job before their kids went to school (not as uncommon as one might think given that affluent people tend to have children later in life, and retire much earlier), and consequently had to report little income on their student loan applications. In cases where their parents still earned a wage these future lawyers had waited until they were 21 and consequently considered independent entities as far as student loan programs were concerned. These circumstances allowed them to apply for and collect student loans when they really didn’t need the money. After all, they didn’t work while going to school because their parents paid for everything, so they had no income to report on their loan applications either. So with this fortunate combination they were able to receive large amounts of student loan money from both the provincial and federal governments. In addition to the loan amount, these people even got automatic grants because they were considered to be among the most “in-need.”
Interest-Free Investment Loan Anyone?
Now many people in their position would have taken the money and had a great time. Who couldn’t use a few thousand dollars worth of beer money in college right? Or possibly one could see themselves buying a nice vehicle of some kind with the money in order to really show off for the ladies/men on campus. Instead, what they did was invest the money. Their foolproof theory was that they would simply invest the money, which consisted of an interest-free loan and a non-repayable grant (essentially free money), and then pay the loan back when it came due a few months after they graduated.
Using A Student Loan To Invest – How To Maximize The Strategy
I’m not saying what they did is right from an ethical perspective, but from a purely financial point of view, this was a great idea. If the students wanted to be cautious, they could invest in GICs and bonds and earn a free 3% or so on the money for the years they were in school before paying it off when it came due; however, I of course would advocate for a different approach. With the markets in a fairly deep correction, I think there are substantial gains to be made over the next couple of decades in equities. I have published articles before on the stock market average returns over the years, and I believe they make a pretty convincing case that business will rebound as it always does after it shakes off the inefficiencies (ok, so this is a lot of shaking over the next couple of years, but still). To get some free money from the government, plus an interest-free loan for a period of years, represents a pretty substantial opportunity to create a little wealth at the beginning of someone’s life. In many cases, it wouldn’t even make sense to pay off the student loans when they came due and started charging interest as well as requiring payments. This is because the loans are usually given at a fairly low interest rate, and the money paid on student loan interest is tax deductible in Canada. This means that your real return on paying the loans back probably would not be as good as investing your money at the moment.
Probability of Being Caught?
I know there are many out there that think this cannot be done, but the more I look at it, the more positive I am that it actually can be. People claim that the government could see the investment activity, but this is easily avoidable if you get another person to invest it for you after gifting them the money. For every possible way you could get caught I’m fairly certain there is a straight-forward way to beat it. Even if there was a theoretical way to catch these savvy loophole-types, the student loan program is so massive that the odds of them getting caught are very low to begin with.
Using A Loan To Invest – Is It Moral?
So if we have determined that the strategy is undeniably effective from a purely money-grabbing standpoint, what message do we get from the “angel” on the other shoulder? Obviously these guys represent the epitome of taking advantage of the system being that they are already wealthy, but what about if a “regular” person used this strategy after they turned 21? Maybe by scrimping, saving, and working some hours (maybe some “cash” jobs) a person could get by and still have money left from their student loan (especially after they turned 21). Would it still be unethical for them to use this investing strategy? The almost-lawyers caught a lot of flack on the site for taking money that could have been better put into the hands of truly needy students, but they actually had a fairly persuasive argument for themselves (who would have guessed). They argued that they and their parents would be in the top pay bracket the majority of their lives and would never take advantage of all the other welfare programs out there for unemployment etc. This would be one of the only times they would be able to get the same “free money” everyone else decided they were entitled to, and really, wasn’t it just a small percentage of their parents’ money coming back to them anyway? Needless to say, these guys are going to be very good at their jobs one day.
Is Buying Luxuries More Permissible Than Buying Stocks?
Is it wrong to use a student loan to invest money for personal gain? I think if you’re going to decisively say that it is, you almost have to claim equally decisively that using student loan money for any luxury should not be allowed. For every student that goes out to eat, buys a round of beers, or a gets a car, there is probably a student out there who could use the money more than them. I’m not sure where I stand. I think it is definitely a misuse of the program, and that it certainly is throwing tax payers money away. On the other hand, I see so many ways that the government to undeserving people, I almost applaud these people in bizzaro-libertarian-Robin Hood-type of way. Instead of robbing from the rich to feed the poor, this strategy takes back money from the government who basically stole it at gun point and use it so inefficiently. At the end of the day I guess I would say that it is not right, but it shows how upset I am with wastes of big government that I would even consider these people to be anything less than dishonest individuals.
Is there a real difference between these forum boasters who are already come from wealthy backgrounds investing student loans, and blue-collar students using a student loan to invest if they have saved their money in various ways? If given the opportunity to enact this guaranteed strategy, would you?
Well, I see it as this:
MANY (what, 90%) of students probably use their student loans for vacations to Mexico as well right? Is that moral?
Perhaps that’s why the government took away the grant associated with the student loans.
I guess this is another example of how the rich get richer!
I had never heard of this until now.. ! Thanks for opening my eyes to the continued flaws in the system lol.
Sorry about making you more cynical Y & T! That’s how I view it too, it certainly doesn’t seem completely fair, but how much student loan money gets poured into bars, casinos, clubs, and student travel businesses? Is this really any better?
I’m pretty sure that I read in the US, this is illegal. However, I don’t know how the government would find out. The strategy could work, but few students are in this kind of situation where they can invest their student loans instead of paying for their education. Interesting idea, though.
So what do you think LH, would you do this if you were in the right position?
I’m sure the IRS would catch this kind of activity if they get audited. Other than that, I don’t think there is a student loan enforcement agency, is there? I think it’s not a bad idea actually. It will teach them more about investment and get them started investing early. These type of investors contribute more to society than consuming students right?
There are ways to get the money off your balance sheet (ie, have your parents invest it in their TFSA for you, and max out their RRSP instead, then when you graduate, pull the money out, and just show it as a “gift” going both ways). Also, not many students get audited. I agree that there may be as much positive as negative going on here.
Well, it sounds good on paper, but I’d think there would be some risk if one got into equities with the money and didn’t know what they were doing. Even if it were legal I don’t think I’d do it. I just have such an aversion to debt.
It’s been a few years since I was in college, but as I remember it, we used to max out the loans so we could have the extra cash for “books and food” aka booze and toys. There certainly wasn’t anyone standing there telling us to not do that, so I find it hard to believe that anyone is going to be standing there telling you that you can’t invest the money either. Of course, the caveat is that if you lose your shirt investing, you’ve still got to pay back the loan, but you’ll probably get more out of it than the booze and toys I bought with most of mine. ;)
P.S. if I had it to do over again, I wouldn’t have taken the extra money. Those payments are a bitch.
Unless you’ve made 10% a year off of them with dividend-paying investments!
This is absolutely fascinating! A few thoughts:
1. Only young adults who were raised surrounded by an investment-focused (as opposed to savings-based) financial situation would even think of this option. This would never even cross my mind.
2. I really don’t see a way they would get caught, except for some really inconvenient search by the government. That would ruin everyone’s lives and I hope they don’t start doing that.
3. I don’t think I would do this, even if I could, because it sounds risky and I would rather allow the money to go to someone who really needs it.
I agree that very few kids would think of this. That’s why I plan on showing my children that money is just a tool, and that blindly putting your money in a savings account is only one part of responsible personal finance. Even if you don’t agree with the morals, you gotta admit that it is pretty creative.
Interesting post!
I don’t think I’d recommend a student who has debt to employ a leverage plan, let alone using their student loan money to invest.
Taking it a step further, investing in the stock market with such funds would not be a good idea, at least in my view.
When I went to university, I had a friend who blew every bit of extra student loan money on going to the bars, buying clothes, traveling, and so forth. Although he got away with it then, it took 10 years for him to pay his loans off. Just because people can get away with spending their loan money irresponsibly, it doesn’t mean they won’t suffer the consequences down the road.
From a personal standpoint, I think leverage investment plans can sometimes work, but using student loan money on a short to mid-term basis doesn’t seem to be a reasonable path to take. Just my thoughts.
Cheers,
TWC
TWC – If you don’t actually need the student loan how is taking one in order to invest any different than souped up investment loan? You get free grant money with it in many cases, no interest for a decent period of time, and then when you pay it back it is tax deductible. Sounds like a pretty great deal to me.
I’m not disputing your math; all I’m trying to say is that if a student already has an accumulation of debt, and then uses new loan money to invest in say, equities, they are exposing themselves to more debt, which can be risky.
In cases where students have everything paid for and don’t have to work during summers because mom and dad have everything covered, then doing ahead with investing the loan money becomes much easier.
The problem I have with it however, is that the loan money is not intended for investment purposes and as a result, would not recommend it to anyone.
Combine that with other factors such as potential negative tax ramifications (which admittedly, seem pretty slim) and just downright feeling lousy about going ahead with such a plan, I think the cons outweigh the pros.
Just the thought of getting another person to invest the money for you after gifting them the money will likely have tax consequences for the person you gave it to.
Overall, the program isn’t meant for investment purposes, and even though our government hasn’t cracked down on those who are abusing it, it doesn’t mean they won’t at one point or another. Again, just my thoughts!
Ya, I agree with you that it isn’t in the “spirit of the rules” regardless of the letter of the law.
I’m not sure there is anything to actually get “caught” about. If they have provided all the information requested for the loan, without omitting that was asked to be reported, I’m not convinced that they’ve done anything that could result in being slapped with a penalty or otherwise “caught”.
It’s up to the lending institutions to set the requirements and if they’ve set them in such a manner that someone qualifies, then that’s that. When I went to law school, I resided in Quebec. I was asked my marital status and read the definition of marital status — married meant only actually married, not just living together. Only married people were asked to report spousal income. I had a partner I lived with, who was earning a salary. But I didn’t report it because that financial information was not requested of me. I assume that I qualified for more loan than I would have had I actually been married to my partner. But I don’t feel I did something I might get “caught” about or even something morally questionable. I was just lucky to fit through this particular loop hole. If the student loan program wants to close the loop hole, it’s up to the program to do so. They were the ones to set the terms, and to define “marital status.” I provided the information they requested.
For the same reason, I don’t think what’s being done here is immoral (again, assuming that no omissions of information that was actually asked for were made). If the program was going to be based on parents’ net worth rather than parents’ annual income, then, that would be up to the program to make that change. I don’t think it’s necessarily morally incumbent upon us to ask ourselves whether we were truly intended to qualify for programs we may qualify for — if we qualify, so be it. If that wasn’t the program’s intent, then it’s up to the program to redefine its terms.
The ethics questions would probably stem from the idea that there is a set amount of money the government can contribute to helping students. If these people are taking money they don’t truly need to help with their education’s, then it theoretically means less for students that probably really need it. Student loans are definitely not in place for investors to take advantage of. All the same, It’s an interesting idea.
Even if the government had limited money to give out. I would want other people to have less money for school. If fewer people graduate, then I have a better chance at making money. The more uneducated the population is the better I can take advantage of them.
You gotta love the honest shark-like competitive spirit that capitalism breeds and rewards baby!
I took out more student loans than I needed for my year of graduate school – and it allowed me to invest the money I was earning as a graduate assistant, while the loans paid for living expenses. But honestly, my loan rates are high enough that it is not really worth it as a financing plan, except that with the price of equities so low (I started grad school in the middle of the recession), I feel like I had a great advantage being able to start to buy into the market at that low point.
The government requires me to pay it back at 6.8%, no matter whether I use it on books, stocks, or booze, so what is the difference? Without the loan money, I wouldn’t have been able to afford grad school, with the extra loan money, I could afford grad school and invest. They’re making money because will be paying it back and not defaulting, and I’m guessing those law students will too. Even if the stocks lose all their value, they will be able to pay the monthly payments with their lawyer’s salaries, the same way kids who needed the money for school will be paying it back.
The unethical part is in whether they should qualify for the loan or not – and as a grad student here in the U.S., it didn’t matter if my parents were working or not – I had a bunch of loans available to me without having to work the system at all, because they no longer care so much about your parent’s income when you’re doing a grad degree.
So Kellen, do you believe you will make enough investment gains in order to offset the interest charges? See in Canada, our student loan payments are tax deductible, so that 6.8% would be a REAL rate of about 4.5% for most people. Suddenly it looks a lot more attractive right? Especially if your going to be in school anyway during this recessionary market. I’d be interested to see what the compounded real returns will be after interest expenses after a ten year time period or so. I think it would be extremely difficult not to make a tidy profit (especially after factoring in the initial interest-free period).
That’s something I argue about with myself every time I try to decide if I should pay off my student loan faster, or keep putting some more money into the stock market now while it’s down.
The interest I pay on student loans is tax deductible, but not the payment itself. So it does reduce the rate from 6.8% a bit. Plus a portion of my loan is only 3% or so. (A very small portion, but it still brings the average down.)
Historical rates suggest that 6.8% may not be super easy to beat, but it’s on the border. However, I think that buying in now, while the market is down, will be a big factor in how big my returns are in the future. So, I havent quite made a decision either way – will pay my loans off in 3 years instead of 10, but I will keep putting a few hundred into the market each month.
Well, you can take comfort in the fact the most “experts” will tell you that your focus on saving either way (investing or paying down loans) is the real key. I’m a bull going forward on the stock market, but that’s just a personal view that I am only slightly qualified to say. I just think economies have went through far worse than this and come screaming out of it before.
I will never forget being in university, as a mature student and dependent on student loans, hearing a couple of female students in the washrooms at the financial aid office celebrating that they will take their grant money and go to the Caribbean. Ha ha. It has stuck with me because I have continued to struggle and find this to be such an injustice to those of us who were not born to “old money” nor had parents who could pay for our education, even if they too struggled to do so.
I wish these people were caught but I suspect they never have been nor ever will. It’s one of those things that gives the less fortunate a contempt for those who abuse their privileged position in life.
See these are the type of stories that make me question whether using a student loan to invest is truly immoral or not. If people use them for going to the Carribbean, why not invest them?
Really interesting article. This largely describes what I am doing right now.
When I applied to University I had personally saved over $13,000 as I worked for 3.5 years (mostly in the summers during high school) before University. I’m also lucky enough to have parents that saved for an RESP account and supported my education.
When I applied for my Alberta student loan, my dad’s income was something like 140k. Even with parental support, I qualified for a $5000 loan.
I saw the loan as an opportunity to invest in a stable dividend paying company and a high interest savings account at ING Direct. I’ll probably make around $1000-1500 in pure profit by the time I return my student loans (now totalling $9000 or so).
Its funny. I have a respectable amount of financial security, yet I still live cheaper than most of my friends. I fully intend on paying my student loan back when I graduate. I fully intend on paying my parents back a few years after I graduate as well.
I would not ever take advantage of a bursary or financial aid. I think it incredibly unethical to take advantage of programs designed for low income students.
However, I do not know a single person who has not been able to get an Alberta student loan. In fact, I’ve heard the government is making the loans even easier to get.
If I’m not taking money from those who need it and returning my loan when I graduate, am I really that immoral?
Well Andrew, the argument could be made that tax payers are footing the bill for the money you are keeping nice and secure in your ING account. I find it interesting you draw such a clear moral line at bursaries, but are totally cool with interest-free loans. From my point of view, you will likely pay crazy taxes in order to support this crazy welfare state we have going for the rest of your life, so you may as well try and grab a little now anyway. Do it guilt free my man!
you can’t invest the money either. Of course, the caveat is that if you lose your shirt investing, you’ve still got to pay back the loan, but you’ll probably get more out of it than the booze and toys I bought with most of mine
I am a student now, and have pondered this idea for awhile. I am working while going to school full time and am JUST making ends meet without having to bust into my loaned money, since I don’t have parents to pay for anything. I am considering on investing some of the money.. I don’t really see anything wrong with it. It would help me a lot.
Let me know how it goes JB2888. I think there are some decent criticisms of the practice, but there is no doubt it can help a person’s personal finances.
I have thought about this for a while and came to the conclusion that it is worth it if you find yourself a bargain. The only people that will not be able to take advantage of this loophole are the truly needy ones.
Financial sense it makes, interest-free loan for the duration of your bachellors (4-5 years), basically a push-start to your personal finances once you graduate OR a cushion in case you can’t find a job in the next 6 months (which is entirely possible given the economy).
Immoral, unethical, smart? I’ll have to go with smart. You have to pay the money regardless of the way you choose to spend it on, most students use it for pleasure and impulse buys (bad indicators of financial planning), you use it to invest and (hopefully) plan for the future.
Personal opinion on student loans: Barely anyone needs them while doing a bachellors, work and study can be done if you put priorities first and manage your time instead of waiting for an invitation to party. For master’s or higher degrees it is debatable whether someone needs the loan or not (I have seen people working full time jobs and doing 2-3 nights a day classes) with medicine and possible law school being the exception (not entirely sure on law school).
I just came across this article in a prospective idea. Seeing the current trends of etf’s in Canada I am certain it is possible to make at LEAST 20% per year. (I’ve made 7.67% on a Horizons leveraged etf since February 12th, 2013 – Now March 29th, 2013) I’m planning on taking a certificate/diploma course; possibly distance which my RESP would cover, all I would need is rent/food money. I’ve considered taking out max student loan and potentially taking out multiple student line of credit’s to invest with. My biggest concern is tax reporting. If I weren’t to put my student loan money into a TFSA with a discount broker (i.e. a margin account where I could leverage) wouldn’t the government notice? Would it be possible to claim the initial investments were gifts?
Hey Spencer, there are a couple of things I’ll comment on right away:
1) I’m fairly certain you will not make anywhere near 20% per year. The historical average for the stock market is 10.4%. Check out my ETF book on this for more details.
2) I would definitely not suggest taking out multiple SLOCs. These start accumulating interest right away and aren’t a great deal in terms of tax treatment or interest rates.
3) You should probably check out a tax professional on specifics. I don’t think I’ve ever head of a margin account within an TFSA before so that’s probably a good starting point.
BTW what makes you think you could do 20% returns just out of curiosity?