What Happens to Unused Student Loan Money?

Excess student loan money can tempt students into unmanageable debt, especially young adults without much experience handling credit, but also become essential to funding an education. Students and their parents have to watch how the student uses the loan, because improper use can eliminate or reduce a desirable tax deduction.

You can use excess student loan money for nearly anything. This means you can pay for all those expenses for which you usually cannot use financial aid, such as cars and off-campus housing. Alternatively, you can give it back to the lender. Federal loans do not allow a prepayment penalty, and most private student loan lenders do not have a penalty either.

Avoid the temptation to use excess student loan money for frivolous purchases, such as concert tickets and eating out. Unless you have subsidized student loans, student debt accrues interest charges the day you get the loan. You want to graduate with as little debt as possible. Ideally, you should spend no more than 15 percent of your income on student loan payments, according to Brian Dakss of CBS News.

Another reason to return excess student loans is that you agreed to only use the money for qualified educational expenses -- this usually means tuition, fees, supplies and related expenses like transportation -- when you took the loan. If you have a private student loan, your lender sends you a W-9S and you certify the funds were used for educational expenses. You can only deduct student loan interest on your taxes when you use the funds for qualified expenses. An IRS audit that finds you used student loan money for personal expenses could revoke the deduction.

If you must use your student loan money, consider spending it on something that may appreciate in value or save you money. For example, you can use the excess funds to pay off credit card debt, which usually has a higher interest rate. You can earn money by putting the funds in a safe investment vehicle, such as a savings account, especially when you have the government paying interest on the debt. Once it comes time to repay the loan, you can with draw on the funds. However, only returning the money guarantees that you won't lose it or use it unwisely.