Starting a Business
Using Student Loans to Start a Business: Is It Worth the Risk?
Chances are, you’ve heard stories of young adults using their student loans to pay for trendy clothes, international trips, fancy dinners—nearly everything except their education. Maybe you know a few of them yourself.
While “living the life” is alluring, what if you put those funds toward starting a business instead? You may be wondering: Is it possible? And more importantly, is it legal?
Well, keep reading to find out.
Can You Use Student Loans for Your New Business?
Overestimating the cost of attending college happens more often than you think. But if you find yourself with funds left over from your student loans, are you allowed to do whatever you want with them?
Technically, it depends on the terms of the loan agreement you signed with your lender. Contracts for federal student loans typically have very explicit terms for what the money can be used for. On the other hand, the agreements for private loans are often more open-ended.
Of course, these legal documents haven’t stopped borrowers from using their private or federal loans for personal expenses. A 2019 survey from Student Loan Hero found that, over summer break, only 10% of student respondents used their loans strictly for tuition. Instead, many used the money for:
- Food (42%)
- Bills (38%)
- Rent (33%)
- Clothes (26%)
- Traveling (20%)
Colleges and universities can’t track what recipients use the money for, so unless you borrow more than the cost of attendance, there’s usually no way for them to find out if you’re using the money for non-specified purposes.
But while it’s not outright illegal to use your student loan money to fund your startup, there’s still plenty of risk involved.
If they find out, lenders can terminate your contract and take the funds back, which also means you’ll need to repay any money you’ve already spent (ugh, more monthly payments). You may also face legal action from your lender and even the federal government—adding legal costs, fees, and penalties to your final bill.
Because of the far-reaching repercussions of this decision, it’s best to raise startup funds in other ways and use your student loans as a last resort. If you feel that there’s no other option available to you, read on for the pros and cons of using student loans for your new venture, plus some ways to help minimize your risk.
Pros and Cons of Using Student Loans to Start a Business
The Pros
- Many students will find it easier to qualify for student loans compared to traditional business financing options, as lenders are typically more lenient with their requirements for student loan borrowers.
- You may be able to get a better interest rate with student loans than with business loans, personal loans, or credit cards—especially if you haven’t built up your credit yet or don’t have the best credit score.
- Student loans allow you to pay back the amount over a much longer period of time, and you can adjust your repayment options if you need to. For instance, some allow for missed payments or temporary payment deferrals. Student loan payments generally start after graduation too, so you don’t have an immediate monthly payment to make like you do with credit cards.
The Cons
- As mentioned earlier, using your student loans for your business is a risky move. Getting caught could expose you to a slew of financial and legal consequences.
- You’ll take on even more student debt—debt that may follow you for years after graduation (and endless monthly payments to budget for). Borrowing more money than you need to will also increase the total amount you owe over time, due to accruing interest.
- Compared to business loans, personal loans, and credit card debt, you can’t discharge student loan debt during bankruptcy. You’ll still be responsible for making payments on the debt even if you don’t have the means to repay.
4 Ways to Reduce the Risk of Using Student Loans for Your Business
1. Determine How Much You Need to Start Your Business
Draw up a business plan to ensure you know exactly how much money you need to cover your startup costs. Some things to take into consideration include:
- Fees, licenses, and credentials needed to establish your business and authority
- Average marketing budget for startups in your niche
- Cost of producing or buying inventory
- Cost of setting up a website or online store
- Money to pay your employees or contractors
- Contingency budget for unexpected expenses
- Any other essential equipment, software, or resources needed to run your business
This exercise also has the added benefit of testing whether your idea is profitable enough to outweigh the risks of using student loans in the first place.
2. Cut Down on Your Living Expenses
Save money on textbooks, rent, food, and other expenses—and put that money toward your business—to reduce your total student debt. This comprehensive list offers college students 50 ways to save money and stretch their budget further.
Keep your cost of living down, cut back on impulse purchases, and sacrifice some of your enjoyment (and discretionary income) today so it pays off in a big way down the road.
3. Find a Business Partner
A business partner willing to finance your startup idea (or one who can access other means of funding thanks to a great credit score) can help lighten the load on your shoulders. The best business partners also carry a wealth of industry-specific expertise that can be even more valuable than the financial resources they bring to the table.
4. Look For Alternative Financing Options
The best way to minimize your risk with student loans is to avoid using them for your business altogether. But if you feel that it’s a necessary risk to take, consider using it as a supplement to other financing options so you use as little of your loan money as possible.
Here are some other ways to raise money for your business:
- Apply for a small business loan backed by the Small Business Administration for the most straightforward way to get business financing.
- Use a credit card to finance your business, since getting one is often easier than applying for a loan. Keep in mind, though, that credit cards typically carry higher interest rates than loans do.
- Look into online lenders. Many offer faster application processes than their brick-and-mortar counterparts, but they may also come with higher interest rates.
- Get a part-time job—or work full-time during the summer—and use the money you earn to fund your startup. Use this opportunity to learn what it takes to run a business and apply those lessons to your own company.
If you do siphon some of your student loan money for your startup, just make sure that all of your educational expenses are covered first. Otherwise, you’ll find yourself taking out even more student loans to cover the difference.
Is It Worth It to Use Student Loans for Your Business? The Decision Is Yours
If you’re a student with a business idea you’re excited about, funding your startup with your student loans might sound like the easiest way to get started. Even so, take some time to make sure that this is the best move for your personal finances too.
Student loan debt is a large financial burden that often sticks around for years—even decades—after you receive your diploma. Plus, there’s also the chance that you may get caught using the money for non-educational purposes.
Remember that student loans aren’t the only way to finance your business. Sure, the story of angel investors swooping in to save the day is nice, but keep in mind that many young entrepreneurs before you have started business empires with a shoestring budget. Think of this as your call to rise to the challenge too.