New businesses are the lifeblood of the modern economy. They bring about new ideas, new innovations, and spark competition that benefits everyone. Recently, there has been a growing concern about student loan debt stopping graduates from starting their own business. According to a recent Gallup-Purdue Index Report, one in four college students who graduated between 2006 and 2015 with more than $25,000 in student loan debt said they’d delayed plans to start their own business.
While student loans can be an obstacle to starting a new business, there are options to make things less difficult for graduates. Let’s look at both the present landscape for aspiring entrepreneurs and how student loan debt can be better managed to put graduates in a position that will allow them to make their vision a reality.
The Current Landscape and Promises For The Future
Rounding up other recent research on the impact of student loan debt on business formation, the State Science & Technology Institute urged policymakers to look for solutions. SSTI pointed out that student loan debt can not only hinder small business formation and high-tech entrepreneurship, but make it harder for companies to retain millennial workers. Politicians and policymakers are taking steps to help graduates manage their student loan debt. The Obama administration, for example, expanded income-driven repayment programs that allow borrowers to make student loan payments that are equal to a percentage of their discretionary income.
For students enrolled in a federal IDR plan, the state of New York now offers a “Get on Your Feet Loan Forgiveness Program” that covers up to 24 months of payments.
Rhode Island has launched a program that lets graduates pursuing careers or starting businesses in key sectors like technology and engineering defray their student loan payments for up to four years. Last year, Rhode Island awarded 215 “Wavemaker Fellowships.”
Student loan relief programs in other states are often aimed at attracting graduates to hard-to-fill positions in professions like teaching and nursing.
During her 2016 presidential election campaign, Hillary Clinton also promised to help entrepreneurs start their own business. Clinton proposed allowing aspiring entrepreneurs to defer their loan payments for up to three years. Clinton also wanted to provide up to $17,500 in loan forgiveness to “social entrepreneurs” and graduates starting new enterprises in “distressed communities.”
While it’s clear that policymakers have made some efforts to alleviate the burden of student loans, borrowers should also take into account the challenges and opportunities before them to take hold of their debt today.
The Challenges and Opportunities For Graduates and Entrepreneurs
It’s important to understand the implications of student loan debt on entrepreneurs. Knowing this, aspiring business owners can better plan and prepare for their future. It will also reveal opportunities to manage the debt better and create opportunities for themselves.
When students graduate, they’re immediately thrown into their careers. This is also the point where payments will begin on student loans. While the long-term benefits of borrowing money for college are evident, it doesn’t change the fact that in recent years, college costs have risen dramatically, outstripping wage growth.
As a result, many graduates are spending more of their income on loan payments, which makes it harder to pursue dreams like starting a business or buying a home. When your monthly debt obligations eat up too much of your paycheck, you have what’s known as a high debt-to-income ratio (DTI), which can make it harder to get a loan.
While student debt alone may not push your debt-to-income ratio into the red, it may limit your ability to take on more debt, including a business loan.
Income-Driven Repayment Programs
One way to reduce the monthly payment on your federal student loans – and your debt-to-income ratio — is to enroll in an income-driven repayment (IDR) program.
Under an IDR plan, monthly payments are tied to a percentage of your monthly discretionary income – typically 10 or 15 percent. If you have no discretionary income, your monthly student loan payment is zero. But because you are stretching your payments out as long as 20 or 25 years without getting an interest rate reduction, you could end up paying thousands of dollars in additional interest. This is particularly true for borrowers who don’t end up qualifying for loan forgiveness. The Department of Education offers a repayment estimator that can help you evaluate your options, but be aware its limitations.
Small business owners should also take care to make their payments on time. If you miss any payments, it can hurt your credit score, which can make it more difficult to secure funding for a growing business.
Refinancing Student Loans
Refinancing student loan debt at a lower interest rate can help graduates reduce their monthly payments, their overall repayment costs, or both. A study by Credible found that students who refinanced into a loan with a shorter repayment term could expect to save almost $19,000 over the course of their new loan.
Refinancing allows borrowers to choose a loan with a shorter repayment term for maximum savings, or stretch out their payments over a longer period of time in order to reduce their monthly payments. Refinancing into a loan with a similar repayment term and lower interest rate can reduce both the monthly payment and overall repayment costs. Depending on the strategy they chose, refinancing can provide additional flexibility for the borrower who is looking to free up some of their income or reduce their debt-to-income ratio so they can secure funding for a new business.
It’s important that borrowers also manage their credit score, which is an important factor that lenders consider. A good credit score can help you get a lower interest rate when taking out or refinancing student loans.
Your credit score is determined by a number of factors. According to FICO, these are the elements that contribute to your credit score:
- 35% – Timely payments on your loans, credit cards, and any other types of debt
- 30% – Amounts owed
- 15% – Length of credit history
- 10% – New Credit
- 10% – Credit mix
While some changes to your borrowing and repayment habits only affect your credit score over time, paying down debt can have an immediate impact.
An important component of how much you owe is your credit utilization – how much of your existing borrowing capacity you’ve tapped. If you have credit cards, it’s best to keep them around or below 30 percent utilization to protect your credit score.
The Key Takeaway: Always Have a Plan
Before you look for funding to get your business off the ground, you’ll need a business plan.
The goal of this plan is to set a roadmap for your business that extends 3-5 years into the future. As part of this document, you will visit several key categories:
- An executive summary
- A description of your company and its unique characteristics.
- Your market analysis to establish your place in the market and competitors
- Business structure and layout
- Service or product line description
- Plans for marketing and sales strategies
- Specific information for when you secure funding
- Projections for your finances
- How to make your business stand out
Drafting this plan is the first step on any successful entrepreneur’s journey. It is here that you’ll find opportunities to cut costs and maximize your funding. Are you a small business owner? Did student loan debt affect your timeline for starting a business? Let us know in the comments!