Dear Penny: Should I Take on Student Loan Debt to Buy a New Prius?

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Dear Penny,

Our Prius needs repairs. We trust our mechanic and the repairs are legit. It has 170K+ miles on it and the newer models get even better gas mileage. We currently have two cars, but since we mostly work from home, we don't really need both. I thought we could consolidate and get one nicer Prius. 

I was shocked to see that even a 2016 Prius is going for like $18K. The base model for the Prius Prime is $28,500 and qualifies for a $7,500 tax credit. So, $21K to buy a new Prius with electrical capabilities, basically zero miles and is under warranty, with a negligible difference in price from the used hybrids. 

The long and short of it is, once you factor in our trade-in values, savings and the tax credit, we’d still need a loan of about $3,500. (I'm aware that we'd have to wait to get it back until we file our taxes.) I know it would be ideal to wait and save, but our Prius needs repairs now. 

I'm also an online student but pay for my education with mostly grants and scholarships. Today I logged into my financial aid account to reject my student loan offers like I usually do and something caught my eye. It says the government pays the interest while you're in school and for six months after. I have two years left. Basically, we could get an interest-free loan. I feel confident we could pay it back before any interest starts accruing.

It seems like a great deal, but my inner frugality is antsy. Is taking a loan ever a good idea? For reference, we are very responsible and have excellent credit because we always pay our bills and have a 100% success rate paying loans off early, though we avoid them when we can. If it helps, it's just me and my husband, and we don't want kids. 

-Frugal Student 

Dear Frugal,

I’m not part of the all-debt-is-terrible school of thinking. Where this gets tricky is that you want to use a student loan to pay for the Prius. Student loans are based on your cost of attendance for school.

The U.S. Department of Education’s cost of attendance formula includes an allowance for books, supplies, transportation and miscellaneous personal expenses. But the Federal Student Aid Handbook explicitly states that student loan money can be used for “costs for operating and maintaining a vehicle that is used to transport the student to and from school, but not for the purchase of a vehicle.”

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In your case, using student loan money for transportation expenses is especially murky. You’re an online student, so presumably, you aren’t commuting to and from campus.

There’s an obvious work-around, though. You can take out a student loan and use it to pay for allowable expenses, like tuition and supplies that aren’t covered by your grants and scholarships, housing and groceries. I’m guessing those costs will add up to more than $3,500. Then you’d free up money in your budget for the car payment.

Realistically speaking, you can’t determine whether you’re spending student loan funds or money from other income sources once the student loan gets deposited into your bank account — unless, of course, you open a separate account for student loan disbursements. But the point is, as long as you don’t borrow more than your cost of attendance, minus grants and scholarships, you shouldn’t be breaking any rules.

In the unlikely scenario that your scholarships and grants cover all your costs of attendance, you could always get a personal loan for $3,500. Since you have strong credit and it’s a small amount, you wouldn’t pay too much in interest.

If you’re confident about buying the Prius, don’t hold off too much longer. Once a manufacturer sells 200,000 electric vehicles, eligibility for the credit starts to phase out. Toyota recently hit the 200,000-vehicle milestone, so barring legislative changes, that $7,500 tax credit will be reduced to $3,750 on Oct. 1.

Also bear in mind that EV tax credits are non-refundable, meaning the credit only applies to money you owe at tax time. For example, if you had a $7,500 EV credit but only owed $2,000, you’d wipe out the $2,000 tax bill but wouldn’t get a $5,500 refund.

It’s not just about the tax credits, though. You’ve clearly done the math and determined that this purchase makes sense. There’s no sense in sinking money into repairs for a vehicle you’re planning to get rid of.

A loan is a bad idea when you use it to buy a lifestyle you can’t afford. But that’s not the case here. As long as you don’t run afoul of Department of Education rules, I don’t see anything wrong with taking on this small amount of debt.

If you have more than $1,000 in your checking account, make these four moves.

Robin Hartill is a certified financial planner and a senior writer at The Penny Hoarder. Send your tricky money questions to [email protected].