Having a student loan has significant consequences for young entrepreneurs. If you want to take business loans to finance your initiative, your student debt might be a barrier to eligibility. The reason behind this challenge is that lenders check credit history and debt-to-income ratio to determine eligibility. Both of these factors are highly dependent on your student loans.
This guide explores the relation of a business loan with a student loan and presents you with some tips to maximize your chance in the application.
What is a Business Loan?
A business loan helps people in need of financial support to start and develop their business ideas. Many banks and credit unions offer such loans. This type of funding is usually desirable because it provides complete protection for the borrower. If the debtor fails to repay the debt, the lenders can liquidate business assets. In most cases, lenders cannot demand personal assets to be liquidated, and this process has less impact on credit performance.
If you want to get a business loan, you need to follow a few steps. First, make sure that you have a feasible business plan. Business plans indicate the purpose of the business, as well as its structure, competitive analysis, development opportunities, finances, etc. Lenders require a business plan because they want to ensure that the business will generate profits for repayment in the future.
Next, you need to determine how you will use the funds. Lenders will ask specific questions in this area to ensure that the borrower has full knowledge and plan for the effective use of funding. Lastly, you need to collect all documents that lenders might ask for, such as personal and business tax returns, bank statements, etc.
Business Loan and Student Loan Debt
It is not surprising that having student loan debt makes it harder for borrowers to get a business loan. The main reason behind this challenge is that lenders check the debt-to-income ratio when determining eligibility for business loans. The debt-to-income ratio indicates how much money is left after covering your debt obligations or if your income can cover obligations multiple times. It is desirable to have a low debt-to-income ratio. In this case, the applicant’s debt obligations are less, and they are credible enough to get a new business loan.
If you have student debt, it is not a complete barrier to getting a business loan. However, student debt should be in reasonable amounts, which does not result in too high a debt-to-income ratio.
How to Change Your Debt-to-Income Ratio?
So, apparently, having student loan debt has a significant impact on your ability to get loans for your small entrepreneurship. But what to do to increase your chance of getting a business loan? Your first strategy should be lowering your debt-to-income ratio. You can achieve this goal in two ways:
- Reducing debt obligations
- Increasing income level
When it comes to increasing income levels, it is straightforward. If you can, get an additional job or ask for a pay raise you have been waiting for a long time. We will discuss reducing debt balance in detail in the following section. If you need further guidance, you can contact our debt specialists in Student Loans Resolved.
Reducing Debt Obligations
If you have federal student loans, you can reduce the owed amount in several ways. For example, you can change your repayment plan. Some repayment plans have shorter payback periods which allows borrowers to pay off debt or at least reduce the obligations quickly. Others have long payback periods but low-interest rates to make repayment more affordable. So, one of your options is speeding up the repayment period to decrease the debt-to-income ratio.
An alternative method can be applied for student loan forgiveness programs. With these programs, you can get rid of the debt fully or partially without even paying a penny from your pocket. For example, Teacher Loan Forgiveness can help you get $5,000 or $17,500 forgiveness in return for five-year service.
Unfortunately, there are not many options to reduce debt balance except paying it off when it comes to private loans.
How to Save Money from Student Debt Repayment for Your Business?
It can be possible to get a business loan, but student loan repayment becomes a barrier for your business development. Sometimes, student loans do not allow borrowers to save enough cash to cover startup costs. In other cases, repaying student loans diverts money from your business. In these conditions, you also have some options.
Lower Monthly Loan Payments
If you want to save money from loan payments and use the extra cash for your business, you can use different methods. For example, federal student loan borrowers can apply for Income-based student loan repayment plans. These plans are based on income level and family size. Besides, they require only a tiny percentage of your discretionary income. Hence, almost anyone with financial struggles can reduce their debt burden by changing the repayment plan.
Meanwhile, private student loan borrowers do not have access to these repayment plans. Instead, they can refinance student loans. Refinancing involves getting a new, cheaper loan and using the money to pay off existing expensive debt. In this way, the new loan has lower monthly payments, and borrowers can save money from repayment.
Monitor Your Credit Performance
Having student loan debt and not repaying it on time can hurt your credit score. When you apply for a business loan, the lenders will perform a credit check and evaluate your credit score. A high credit score indicates credibility, and such borrowers have a higher chance of getting a business loan. Meanwhile, a low credit score will be a barrier to getting a new loan. Therefore, you need to ensure that your credit performance is outstanding.
Sure, new graduates usually have no credit history, and their scores are low. However, you need to ensure that you make monthly payments on time and in full amount when repayment starts. In this way, you can improve credit performance and get a higher chance to receive a business loan.
Student Loans and Credit Score
Establishing good credit performance will help you access other opportunities like a business loan or mortgage. You can improve your credit score through student loans which are good debts. If you approach repayment responsibly, you can achieve success in credit history. Here are several details you need to know regarding student loans and credit performance.
1. Installment loan
Student loans are installment loans. Such loans require debtors to repay debt – original balance- together with its interest rate over a long period. When the installment loan is paid off, both original balance and interest, the account is closed. Meanwhile, there also exist revolving credit accounts that stay open in case you use them in the future. For example, a credit card is a revolving account. As you use it, you get a new debit balance.
2. Debt-to-Income Ratio
As mentioned before, the debt-to-income ratio indicates your obligations compared to your earnings. It is usually calculated by adding up all debt payments. Then, you need to divide this amount by monthly gross income. It is advisable to have a lower ratio to maximize your chance to receive a business loan. Besides, there exists a debt-to-income utilization ratio. This ratio shows how much debt you can get vs. how much obligation you actually have. So, again, a lower ratio is desirable for lenders and borrowers.
3. Deferment Period
When you get a student loan, you might not be required to start repayment while you are enrolled in school. Besides, sometimes you can request loan forbearance or deferment. Forbearance is a temporary non-repayment period due to financial challenges.
Meanwhile, deferment is a temporary non-repayment period due to school or active service in the military. In both cases, be aware that your loans can still appear in your credit check even if you are in deferment or forbearance period. Hence, while applying for a business loan, lenders will consider student loans for eligibility.
4. Get Familiar with Loan Terms
When you apply for a student loan, you need to understand that it is a long-term obligation. Therefore, you have to ensure that you are familiar with the terms like repayment plans, interest rate, payback period, etc. Besides, you need to know exactly how much you will pay monthly. In this way, you can plan your budget accordingly and make payments on time and in the total amount. It is essential to maintain your credit score. Keep in mind that if you miss your payments, your credit performance will be damaged. As a result, you will face difficulties in accessing other options, like business loans, too.
What Other Alternatives Exist for Financing Your Business?
As a student with student debt, it will be hard for you to find a business loan. Besides, even if you find a business loan for students usually has higher interest rates. As your credit performance is not outstanding and you are still young for entrepreneurship, lenders consider your request as risky. Hence, to minimize their potential losses, lenders might ask for extremely high-interest rates. Sure, repayment can be a barrier to successfully developing your business when your student debt is expensive.
In this case, it can be more suitable if you find alternatives to business debt. In the following sections, we present you with several options to consider before applying for a business loan for students. If you like any choice, make sure you check it thoroughly and analyze its suitability to your budget and business plan.
Personal loans also exist if you need financial support. These loans are usually for personal issues such as unexpected medical expenses or wedding arrangements. Generally, lenders define how you can use personal loans. Some lenders might not allow using this type of funding for business purposes, but you can still look for a personal loan for your business.
The benefit of personal loans is that they do not have many requirements as a business loan does. For example, even if your credit score is average, you can still find a personal loan lender. Besides, you do not need to put collateral for this type of funding. It means, if you fail, your home or business will not be at risk.
However, there also exist some drawbacks. For instance, it is not easy to get rid of a personal loan. Moreover, if you fail your business and declare bankruptcy, you will mainly be required to continue repayment for this debt. Besides, your lender can send you into collections. Additionally, your credit score can be highly negatively impacted. So, consider both advantages and disadvantages of personal loans before applying.
Small Business Administration Loans
Another alternative to a business loan is a Small Business Administration (SBA) loan. This type of funding is more suitable for business owners due to its benefits. When you start a business, a lender of a business loan might hesitate to accept your request because it is risky. However, SBA loans aim to help these business owners. The program guarantees some portion of the loan. Therefore, lenders are more likely to take the risk and give a business loan.
It is possible to get a loan as small as $500 or up to millions with this program. The eligibility conditions for the loan program include:
- U.S citizenship.
- Owning a for-profit business.
- Your equity in the company.
- The inability to find other alternatives for funding.
Credit Cards for Businesses
You can also get a business credit card for your expenses. However, it is advisable to get a separate card from your personal card if you need a revolving credit. We explained the difference between revolving debt and installment loans above.
Credit cards can make your tasks easier when it is time for paying taxes. As you use this card only for business purposes, you do not need to worry about separating personal expenses. Besides, it can improve your credit history and make access to a business loan easier in the future.
There also exist some reward programs for business credit cards. For example, you can get cash backs or zero interest on purchases during special times.
However, keep in mind that getting a credit card can be a wrong idea if you have a low credit score. Under such conditions, your credit card interest rate can be high and prohibitive for your business.
Additionally, some credit card companies require users to sign a personal guarantee. It means, if your business fails, you will be responsible for paying credit card debt. Unlike a business loan or SBA loan, your debt will not disappear when you file for loan bankruptcy. Hence, be cautious about this guarantee requirement before getting a card.
Angel Investors and Crowdfunding
Another type of funding for a business loan is through Angel Investors. Those are wealthy people who are willing to invest in your business. They give you a loan in return for returns from your company. Besides money, they help businesses with professional advice, networking, etc. However, getting funding from Angel Investors can mean giving up some control over your business, so be careful. Additionally, you can generate funding through Crowdfunding. Different from Angel Investors, Crowdfunding allows business idea owners to get money from various individuals. This type of funding is different from loans, and you do not need to repay it. Yet, there is no guarantee that you will be able to generate the money you need.