You can be on Entrepreneur’s cover!

How to Start a Business With Student Loans and Not Go Broke Launching a business when you have thousands of dollars in debt is a tricky move. Here's what you should know before you take the leap.

By Monica Mehta

entrepreneur daily

Opinions expressed by Entrepreneur contributors are their own.

workreimagined.aarp.org

Finance expert Monica Mehta offers advice to entrepreneurs tackling real-world personal finance issues. Ask her a question and your query might be the inspiration for a future column.

Q: I want to quit my job to pursue a startup, but have $35,000 of student loan debt. Is there a way to shrink my loan payments while we are trying to get off the ground? -- Eric Lee, Austin, Texas

Today student loans represent the single largest debt burden for people under 40. In fact, from 2004 to 2009, only 37 percent of federal borrowers managed to make timely payments without postponing or becoming delinquent. Those most likely to default are unemployed or underemployed. Startup life, where income is anything but certain, qualifies you for the high risk camp, so it's important to know your options.

There are a handful of alternatives to help you reduce your debt burden in the short term. The first step is to identify whether your student loans are federal, private or a combination of the two.

Federal loans can be consolidated to reduce monthly payments. While you won't be able to lower your rate, extending your term from 10 to 25 years will reduce the amount you owe each month by 40 percent, from $402 to $267 per month. Selecting a graduated pay option can further minimize upfront payments. Borrowers start with a reduced monthly payment, which gradually increases after year two and four, settling into a higher standard monthly payment in year six for the duration of the loan.

Federal borrowers facing periods of low or no income can also file for Income Based Repayment (IBR) or Pay As You Earn (PAYE), which cap your monthly payments to a percentage of what you earn, not what you owe, according to Gary Carpenter, CPA and Executive Director of National College Advocacy Group, which supplies information regarding student loans. This means that if your income suddenly drops or stops altogether, you may have a zero monthly balance.

Monthly payments under IBR and PAYE repayment plans are capped at 15 or 10 percent of your discretionary income, based on federal guidelines. Borrowers must qualify and file an application annually with the Department of Education. And under new law, any balance remaining after 20 to 25 years of consistent payment will be forgiven.

As of 2012, only 700,000 borrowers were enrolled in IBR. The Obama Administration estimates that IBR could reduce payments for 1.6 million borrowers.

Options to defer private student loans are more limited. Few private lenders consolidate loans, and even those that do won't reduce your rate or extend repayment terms. Most will offer need-based forbearance, or a 12-month break from making payments. Some offer up to three 12-month grace periods to defer payments.

It's important to note that short-term debt relief is not without long-term pitfalls. Reducing your monthly payments does not make the debt go away. Simply stretching the term of a $35,000 federal loan from 10 to 25 years triples the interest due over the lifetime of the loan, from $13,000 to $39,000. And when the amount you pay each month doesn't cover interest, negative amortization can cause your loan balance to grow exponentially.

Taking the easy road today may set you up for a tough climb later. "Young people often focus on today's cash flow, ignoring they have the work of their life ahead of them," says Eleanor Blayney consumer advocate for the CFP Board, a non-profit that qualifies investment professional to become certified financial planners. "Electing for a long repayment cycle can set you up for debt drag that eclipses other important milestones in life such as buying a home, preparing for retirement and saving for marriage and children."

As an alternative to dragging out your loans, consider crafting a pre-emptive savings strategy to help you stay current while income is influx. In Eric's case, that means you'd aim to save two years worth of payments or $10,000 for an outstanding balance of $35,000. To build your nest egg, consider working in your present job a little longer or take on a consulting gig to throw off extra income.

Budget six to eight months to earn more and make lifestyle sacrifices such as taking on a roommate, cutting down meals out and extraneous expenses to help you save. An easy to use monthly payment calculator can help you determine your budget.

Despite the inability to shake student loan debt, more than 14 percent of borrowers have loans that are overdue. "If down the road you get into trouble, don't ignore your student loans. They can't be discharged in bankruptcy. They will be around no matter what," says Carpenter. "Contact your lender to create an alternative payment plan They don't want to see your loan go into collection either."

The bottom line is that getting a pass today means you're electing to double-down on your future success. Adding $26,000 to your interest burden won't seem like a lot if your business is successful but there's no escaping the fact that you are digging the hole deeper and reducing your financial flexibility. The preferred solution would be to find a way to save as much money as you can during the startup phase and leave the structure of your debt unchanged. Think about how you can really rein in personal expenses in the near term. You'll be better positioned to pursue the startup route and will maintain some of your financial freedom.


Monica Mehta

Author and Investor at Seventh Capital

Monica Mehta has spent the past 15 years investing in and advising hundreds of entrepreneurs. She is an investor at New York-based Seventh Capital and author of The Entrepreneurial Instinct (McGraw-Hill, Sept 2012). Read more at monicamehta.com.

Want to be an Entrepreneur Leadership Network contributor? Apply now to join.

Editor's Pick

Side Hustle

He Took His Side Hustle Full-Time After Being Laid Off From Meta in 2023 — Now He Earns About $200,000 a Year: 'Sweet, Sweet Irony'

When Scott Goodfriend moved from Los Angeles to New York City, he became "obsessed" with the city's culinary offerings — and saw a business opportunity.

Marketing

I Got Over 225,000 Views in Just 3 Months With Short-Form Video — Here's Why It's the New Era of Marketing

Thanks to our new short-form video content strategy, we've amassed over 225,000 video views in just three months. Learn how to increase brand awareness through short-form video content.

Branding

94% of Customers Say a Bad Review Made Them Avoid Buying From a Brand. Try These 4 Techniques to Protect Your Brand Reputation.

Maintaining a good reputation is key for any business today. With so many people's lives and shopping happening online, what is said about a company on the internet can greatly influence its success.

Personal Finance

How to Get a Lifetime of Investing Experience in Only One Year

Plus, how day traders can learn a lesson from pilots.

Productivity

6 Habits That Help Successful People Maximize Their Time

There aren't enough hours in the day, but these tips will make them feel slightly more productive.

Growing a Business

Looking to Achieve Your Goals But Don't Know Where to Start? Try These Proven Goal-Setting Strategies.

Find a more effective way of creating – and achieving – your goals. Get clear on your vision, make your plan, take action, reassess and then revise.