Student Loan Spending Rules: What’s Legal and What’s Not

When you take out student loans, the funds go to your school first to cover tuition and fees. If there's money left over, you might receive a student loan refund. It can be tempting to use that extra cash for non-school expenses, but student loan money comes with strict rules on how you can spend it.

So, is it illegal to use student loan funds outside of school expenses? This guide explains the rules for spending student loan money and the potential consequences of misusing it.

Can I use student loans for non-school expenses?

Federal and private student loan funds are meant to cover education-related expenses only, such as tuition, fees, living expenses, books, supplies, and equipment. Using student loan money for non-school expenses, like clothing, vacations, or dining out, is not allowed.

When you take out federal student loans, you agree to these terms in the Master Promissory Note (MPN), a legal contract that requires you to use the funds for qualified educational expenses. Private student loans have similar rules, but the details can vary by lender. You'll find these terms in your loan agreement.

If you misuse student loan money, you could face consequences, including having to repay the funds immediately.

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What happens if I misuse student loan money?

When you sign the Master Promissory Note, you're agreeing to use student loan funds only for education-related expenses. If you spend the money on non-school expenses, you're breaking that agreement, which could be considered fraud and illegal. The consequences depend on the situation.

“If a student uses federal student loan money on non-educational expenses, they may face lender or legal consequences. A student may be required to repay any non-educational expenses that were misused and, in some cases, pay fines,” says Francesca Reed, vice president of enrollment management and marketing at Neumann University, M.S.

The Department of Education (DOE) allows people to report the "theft or misuse of federal student aid" through the Office of Inspector General Hotline. If you're found guilty of misusing federal student loans, you may be required to repay the full loan immediately.

Under federal law, other consequences can include fines of as much as $20,000 and up to five years in prison. If you misuse private student loan funds, you could face penalties or other negative actions from your lender.

“If you've misspent federal student loan funds, the DOE can demand repayment or even sue. A private lender may consider you in default and require that you repay the loan in full. That's why it's important to be disciplined,” says Martin Lynch, president of the Financial Counseling Association of America.

See Also: Average Cost of College: Tuition, Fees, and More

Acceptable uses of student loan funds

Student loans are meant to cover costs related to your education — just like a business loan is meant for business expenses and a mortgage is meant for a house.

“Whether you take out federal or private student loans, your student loan funds can be used to cover anything that falls within your school's official cost of attendance calculation,” says Bethany Hubert, financial aid specialist at Going Merry by Earnest.

This means some expenses are allowed, while others aren't. Here's a list of acceptable expenses for federal student loans:

• Tuition and fees
• Living expenses for housing and food (such as rent and groceries)
• Utilities
• Books for your college education
• Course materials
• Supplies and equipment needed for classes
• Transportation expenses (public transportation or gas and maintenance on your existing vehicle)
• Disability costs
• Childcare costs
• Study abroad programs (must qualify)
• Miscellaneous costs that qualify (such as a computer to do your schoolwork)

“These should be items that are essential to support the student's educational success,” adds Reed.

What student loans should NOT be used for

Student loan funds are meant to cover educational expenses. While some costs are clearly allowed, others fall into a gray area.

For example, using student loan money for rent or a computer needed for school is typically acceptable. But spending it on luxury items for your apartment or personal expenses like a smartphone isn't allowed.

Here's a list of things you shouldn't spend student loan money on:

• Personal vacations (only eligible study abroad programs qualify for federal financial aid)
• Wardrobe items
• Buying a car
• Restaurants
• Movie tickets
• Concert tickets
• Video games
• Plants
• Pets
• Down payment for a house
• Business purchases
• Investments, such as in the stock market, for personal gain

None of these are considered qualified educational expenses because they aren't necessary for completing your degree or directly related to your studies.

There are also some gray areas to be aware of. For example, you might assume student loans can be used for educational expenses like professional certifications.

However, Jack Wang, a college financial aid adviser at Innovative Advisory Group, clarifies that this isn't allowed “unless those certifications or designations are required for the college degree program.”

How to budget student loan money responsibly

Since you'll need to repay what you borrow, it's important to budget your student loan money carefully.

Typically your student loans go directly to the school to cover tuition and fees first. If you get a refund, look at the other college costs you still need to pay for like books, rent, and transportation.

Here's how to create a budget for your student loan money:

1. Confirm your loan amount: See how much student loan money you're working with to help you set a budget.
2. Review education costs: Write down each type of expense and determine an appropriate amount to use in each budget category.
3. Track expenses: Track your expenses to ensure you're staying within your budget. Checking in weekly can help you spot and fix any overspending before it becomes a bigger issue.
4. Explore alternative funding: Student loans cover educational expenses, but not personal costs. To cover those, consider getting a part-time job, starting a side hustle, or freelancing. You could also offer tutoring services in a subject you excel at.