What Happens If You Misuse Your Student Loans

Individuals can be legally prosecuted and face fines or imprisonment in financial aid fraud cases and instances of illegal borrowing. (Getty Images)

Many college students make poor decisions with their student loan refunds – spending the money on noneducational purposes, such as spring break vacations and buying new clothes.

Accounts of student loan misuse are easy to find – and usually don’t shock the Student Loan Ranger. However, we were surprised by one recently buzzed-about way to spend student loan funds: investing in cryptocurrencies.

Such findings may be questionable, but many instances of student loan misuse are clear. Here’s what borrowers need to know to avoid misspending their aid.

How You Can Use Federal Financial Aid

According to the Department of Education’s Office of Federal Student Aid, “All loan funds must be used for your education expenses.” Education expenses include tuition and fees; books and supplies; and general living costs.

[Take these steps to understand student loan interest rates.]

Those first two categories define specific eligible purchases. Tuition and fees are paid directly to the school before the student receives their loan refund. For living costs, however, students can make a wide range of qualified spending decisions – and they don’t have to be cost-conscious when making them.

For example, if you commute to school, you may need a reliable car to get to class. That might mean you purchase a more expensive new car instead of a used vehicle. Other living expenses include meals. You’ll need food – and maybe you prefer takeout to generic groceries. It’s possible you’ll need to buy clothes for a presentation or on-campus job interview.

Using student loans to invest in cryptocurrencies presents a more difficult rationalization. While these digital or virtual currencies that use cryptography for security offer pros and cons when paying for your education, it’s much harder to say they are a necessary educational expense. This is true for any other type of investment.

Penalties for Misuse

Outside of financial aid fraud cases and instances of illegal borrowing in which individuals can be legally prosecuted and face fines or imprisonment, not much happens to borrowers who misuse their federal student loans.

[Read how to pursue a federal student loan discharge as a victim of college fraud.]

Schools issue refunds directly to students. After that, the financial aid office doesn’t have the means to track how borrowers spend their money. But a new initiative from the Department of Education to issue loan refunds on debit cards may change that in the future.

As a result, many schools don’t actively look for misuse. If a college’s financial aid officefinds out a student has used loans inappropriately, the school can report it to the Department of Education via a hotline and retroactively take the misused money back. This would make the student liable to the school for those funds.

Students can accrue additional debt by misusing their loans. Borrowers end up paying for clothes, gaming systems and other nonessential items for years to come – and at greater costs due to accrued interest. They may also be unable to afford actual needs, such as rent, if they exhaust their refunds early in the semester.

Misusing financial aid can also affect other students. Funding, such as state and institutional financial aid, may be limited and awarded on a first-come, first-served basis. That type of system can’t factor in whether borrowers truly need the entire amount.

Think about it: While one student feels comfortable about spending loan money on spring break or bitcoin, another could need those funds to cover a tuition gap. Unfortunately, the student with the tuition gap submitted his or her application later than the first student. But both students will be hurt financially by their decisions.

[Learn when to decline a loan.]

Think Before You Borrow

Financial aid award letters will arrive for most students this month. In the letter, you’ll have the option to accept or reject all or a portion of the student loans offered. Before borrowing the full amount, the Student Loan Ranger advises students to take time to assess their financial needs fully.

If this is your first year in college, calculate your own cost of attendance – don’t rely on the school’s estimate. You may need less money for personal expenses than the school projects. That could certainly be the case if you’ve already spent time in school. The Student Loan Ranger also recommends reviewing your previous spending to ensure your borrowing matches your needs.

Keep in mind that if you reject part of your federal student loans, you may be able to borrow additional amounts later if it’s in the same academic year. At that point, you’ll be sure that money went toward an appropriate purchase – and not on nonessential spending.

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