Can You Take Out a Business Loan with Student Loan Debt?
While it’s not impossible to take out a business loan with student loan debt, it is a lot harder. Lenders are more likely to approve loan applicants with a long, successful track record, excellent credit, and low debt levels. An entrepreneur with student loan debt or other outstanding personal loans usually has none of these characteristics.
That said, there are steps you can take to improve your chances of approval. Of course, if you are approved, responsibly managing both loans will still be a challenge.
Therefore, to help you successfully finance your business despite student loan debt, this post will provide tips on:
- How to get your loan application approved.
- Finding business loans that are easier to qualify for.
- Responsibly managing a business loan with student loan debt.
How to Get Your Business Loan Application Approved with Student Debt
When deciding to approve or reject a loan application, lenders use what is called the Five C’s of Credit:
- Character: represented by your credit history.
- Capacity: measured by your debt-to-income (DTI) ratio
- Capital: the amount of money you have
- Collateral: an asset that can secure your business loan.
- Conditions: the type, purpose, amount, and terms of your loan
Improving your credit history, lowering your DTI ratio, or increasing your wealth will make your loan application more likely to get approved. Similarly, putting up valuable collateral (such as real estate) or applying for certain loan options also makes it easier to get approved.
If you have lots of student debt, the best way to improve your chances of loan approval is to pay down your debt. Lenders typically want to see a DTI of 43 percent or lower. So if your DTI is near or above 43 percent, you’re unlikely to have your application approved.
Keep in mind improving on one, two, or even three of the Five C’s doesn’t guarantee approval. Even if everything else on your application is strong, it can be rejected if, for example, your credit score is too low.
If you’re unable to improve your business loan application, you should consider other kinds of business financing.
Financing Alternatives for Entrepreneurs with Student Loan Debt
Generally speaking, loans with shorter terms, lower amounts, and higher interest rates are easier to qualify for. Here’s why:
- Shorter terms present less risk to the lender that your situation will change and you’re unable to pay.
- Lower loan amounts limit the amount of money a lender risks losing if you default.
- Higher interest rates result in larger profits for lenders, which makes them more willing to take on more risk.
This means that short-term working capital loans, microloans, and lines of credit tend to have more lenient eligibility requirements.
Also, online lenders are typically much less strict than traditional lenders such as banks and credit unions. That said, online lenders generally charge higher interest rates.
You might also consider non-loan financing options such as:
- Purchase order financing
- Merchant cash advances
- Invoice factoring
Managing a Business Loan with Student Loan Debt
When you already have debt, taking on more comes with risk. This makes it even more vital to create a budget, build an emergency fund, pay on time and in full, and closely monitor cash flow.
It’s also important to understand the differences between student and business loans. Once you do, you’ll have a better sense of the options available for managing both loans.
Business Loans vs. Student Loans
In terms of general structure, business loan payments are similar to student loan payments. You take out the loan for a certain amount, with a certain interest rate, and you pay it back over time. That, however, is where most of the similarities end.
Student loans have grace periods, a predetermined period after you graduate before your first payment is due. Also, federal student loans offer many possible repayment plans. According to Investopedia, these plan options include:
- Graduated repayment: Starts low and increases monthly payments as time goes on.
- Extended repayment: Lengthens your loan period, which lowers your monthly payment.
- Income contingent repayment: Determines payment based on your income.
- Pay as you earn: Limits your monthly payments to 10 percent of monthly income for qualified borrowers.
Despite this repayment flexibility, student loans are notoriously difficult—but not impossible—to discharge in bankruptcy.
In addition, student loans are considered consumer debt whereas business loans are business debt. This has implications for how you manage your finances. For accounting purposes, you must pay business loans with your business’s funds and student loans with your personal funds.
Business loans may or may not have grace periods. Also, your only repayment option on a business loan is the one attached to your loan offer. Like student loans, you can defer small business loans. However, deferment is usually only allowed for a very limited time and your loan will still accrue interest.
Finally, except for some private student loans, business loans tend to have comparatively higher interest rates.
Conclusion: Be Cautious When Applying for a Loan With Student Debt
While it is risky and difficult, obtaining a business loan with student loan debt is feasible. As mentioned, though, obtaining the loan is just one step. Effectively using your financing requires a responsible, conscientious approach to your finances.
If you decide to pursue a business loan, educate yourself about the risks involved. Create a plan that outlines how and when you’ll pay off your debts. Finally, give yourself a large cushion of savings and don’t take a larger loan than you need.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.