There are many reasons one may want to start their own business. Perhaps there is a profitable gap in the market they know they can fill. Maybe it’s the flexibility and freedom of being your own boss. It may give them a sense of purpose and passion. Regardless of the reason, there is a unifying factor in entrepreneurship. It costs money.
Unfortunately, it is not easy to calculate precisely how much it may cost to start a business. According to the U.S. Small Business Administration (SBA), most home-based franchises may cost only $2,000-$5,000 to start, but even this varies. What product is a business selling? Does it require renting space for physical inventory? Will they require a website to be built for them? Will they need additional employees and thus need to afford their payroll? Something as simple as office supplies is still an expense. These costs could mean an entrepreneur could pay tens or even hundreds of thousands of dollars to open their doors when added up.
When finding this capital, it is essential to remember the adage; “there ain’t no such thing as a free lunch.” Someone with clean credit could take out a small business loan; however, these will need to be paid back with interest. Venture capital investors may be willing to help, but you will need to sacrifice some company ownership to them. Success in crowdfunding on sites such as Patreon or GoFundMe still requires specific fulfillments to backers to be met. If not, it could result in poor public opinion, and the business fails before opening its doors. Such risks are why reports from financial software company Intuit show that 64 percent of small business owners use their personal savings to fund their company.
According to the U.S. Bureau of Labor Statistics, only a third of new small businesses will remain after ten years. The U.S. Bank reports that about 82% of these failures are due to cash flow, creating a massive concern for entrepreneurs funding businesses with their savings. The answer some owners decide on in an attempt to stay open is drastic; not paying themselves. According to financial service firm Kabbage, approximately 30-50% of business owners choose to forgo a salary for multiple months. So exactly how are these business owners supposed to not only keep their doors open but afford their living expenses?
It is clear that in this scenario, a business owner will need to be frugal and cut down on personal expenses. The 2019 Consumer Expenditure Survey from the Bureau of Labor Statistics reports that, depending on family size, monthly expenses on average range from $3,189 to $6,780 a month, many of which are unavoidable. However, you can take action on some of these expenses to better budget for your business.
One of these unavoidable expenses is, for those that have them, student loans. According to Quicken financial software, student loans are among the top 20 expenses in peoples’ monthly budgets, with 69% of college students in the class of 2019 taking out student loans and 14% of their parents have taken out Parent PLUS loans. A 2015 report from the American Student Assistance (ASA) shows that 61% of borrowers interested in starting a small business indicate that their student loans have affected their ability to do so.
Just how expensive are these student loans? According to educationdata.org, the average monthly student loan payment is $393. When we include the average monthly expenses reported by the Bureau of Labor Statistics, for a one-person household, approximately 12.3% of their monthly costs are just for their student loans. This cost has a massive impact on a business if the owner solely funds it. Just what are the risks a borrower faces when they don’t pay their student loans?
How a Defaulted Loan Will Affect You
The punishments for defaulting on these loans are far more severe than simply affecting your credit score, which would already make taking out small business loans difficult. If your loans are from a private lender, they can take you to court and demand repayment and, if granted permission, garnish your wages or seize your assets. For those that have taken out federal student loans, after 90 days of delinquency, your loan servicer will report this to the three major national credit bureaus. After 270 days of failure to pay, your loans will officially default. While defaulted, your federal loans will be ineligible for any federal forgiveness programs that exist for borrowers, and the interest rate on these loans can go up to 22%. Additionally, 15% of your disposable income will be taken through (AWG) active wage garnishment, and a borrower can be put in tax offset, denying them from getting the tax refund they expected.
Those who believe they can get away with missing a few payments and paying back any additional expenses when their new business starts booming will find themselves putting a “permanently closed” sign up sooner rather than later.
Of course, most default cases are not because the borrower is trying to temporarily “beat” the system but because they genuinely cannot afford their student loan payments. However, this does not mean they are powerless.
Defaulted Private Loans
Your options will be limited for private student loans based on the terms agreed upon when taking out the loans. A servicer may allow the borrower to rehabilitate their loans through a certain amount of “good-faith payments,” removing the default afterward. A private lender may also be willing to negotiate a new repayment option or even a default settlement through a lump sum payment. Another option is to refinance the loan to a more affordable payment and perhaps a better interest rate; however, this can be difficult to do if the loan is in default and already affecting your credit score. Therefore, this is a wise option to explore if you know beforehand that you will go into default on your current loan. It is also essential to be aware of your rights as a borrower, including laws laid out by the Federal Trade Commission, Consumer Financial Protection Bureau, and your state’s statute of limitations. Consulting a student loan lawyer may be the best option for those needing help on defaulted, private student loans.
Defaulted Federal Loans
It would be unwise to think getting a federal loan out of default is any easier. There are three options regarding federal student loans, given that your loan types and history are eligible. The first option is to pay the loan off in full; however, it is unlikely that this is an option. The other two options are loan rehabilitation and loan consolidation. While loan rehabilitation takes several months to complete, you can quickly apply for loan consolidation. However, loan rehabilitation provides certain benefits that are not available through loan consolidation.
Loan Rehabilitation
To rehabilitate a defaulted Direct Loan or Family Federal Education Loan (FFEL Loan), you must first contact your loan holder and agree in writing to make nine voluntary, reasonable, and affordable monthly payments (as determined by your loan holder) within 20 days of the due date and make all nine payments during a period of 10 consecutive months. Under this agreement, your loan holder will determine a reasonable monthly payment equal to 15% of your annual discretionary income. Therefore you will need to provide documentation of your income to the loan holder. If their calculated “reasonable monthly payment” is still unaffordable, a borrower can request an alternative payment method based on monthly income against monthly expenses. This method will require documentation of your monthly income, expenses, and an income and expense information form. It is important to note that if your collector is already collecting payments through wage garnishment or tax offset, these will not count towards the nine voluntary payments and will continue until the loan is out of default after those nine payments. However, you can appeal to have garnishment and tax offset lifted after five months into the rehabilitation process.
While a longer process than loan consolidation, the benefit of loan rehabilitation is that once completed, the record of default will be removed from your credit history (although your credit history will still show late payments that the loan holder reported.)
Note that loans are only eligible for rehabilitation once. If the same loan is defaulted on again, then the only options out of default available are loan consolidation or to pay the loan off in full. The only exception to this is if the first rehabilitation took place before August 14th, 2008.
Loan Consolidation
Loan consolidation allows you to pay off one or more federal student loans with a new Direct Consolidation Loan.
To consolidate a defaulted federal student loan into a new Direct Consolidation Loan, you must either agree to repay the new Direct Consolidation Loan under an income-driven repayment plan or make three consecutive, voluntary, on-time, full monthly payments on the defaulted loan prior to consolidating it. If you choose the second option, your loan holder will determine the required payment amount. However, that payment cannot be more than what is reasonable and affordable based on your total financial circumstances.
There are special considerations if you want to reconsolidate an existing Direct Consolidation Loan or FFEL Consolidation Loan that is in default. If the defaulted loan is a Direct Consolidation Loan, you must include at least one other eligible loan in the consolidation. Additionally, it must meet one of the two requirements previously described. If you have no other eligible loans to include in the consolidation, you cannot get out of default by consolidating a defaulted Direct Consolidation. Your options are repayment in full, or if an available option, loan rehabilitation.
FFEL (Federal Family Education Learning) Consolidation Loans can be reconsolidated without including any additional loans in the consolidation, but only if you agree to repay the new Direct Consolidation Loan under an income-driven repayment plan.
It is critical to note that if the defaulted loan is being collected through wage garnishment or tax offset, you cannot consolidate the loan until the wage garnishment or tax offset has been lifted.
While this is a faster process than rehabilitation, the defaulted loan will remain on your credit history.
Preventing Default
Of course, the best scenario is to avoid falling into default. You can significantly reduce the risk of defaulting on student loans by preemptively budgeting, refinancing, and getting on the best payment plan.
Budgeting
When determining your budget, the Department of Education recommends that students not take on a student loan payment that exceeds 20% of total projected discretionary income, or 8-10% of total monthly income. Once you know your adjusted gross income, use the federal poverty guidelines for your state and family size and multiply the poverty amount by 150% and subtract that number from your income to determine what your discretionary income should be. Note that your annual gross income and family size may be different than you expect based on your tax filings.
Refinancing and Income Driven-Repayment Plans
Refinancing student loans can both decrease your monthly payment amount as well as your interest rate. Make note that refinancing a federal student loan will change it to a private student loan, making it ineligible for any federal forgiveness programs and could be limited in options for default resolution if they still end up defaulting. This risk is why, for federal student loans, going on an income-driven repayment plan may be the best option.
Income-driven repayment plans base your monthly payments on your adjusted gross income and family size. Because these variables are prone to change, a borrower on an income-driven repayment plan must recertify their income and household size annually. Income-driven plans generally result in cheaper payments than standard repayment plans.
For example, using data from educationadata.org, claiming the average federal student loan debt being $36,510 per borrower, and the Society for Human Resource Management’s report on the average salary for recent college graduates being around $51,000, the borrower could expect to pay $420 under a standard repayment plan. On an income-driven plan, they would pay approximately $274, assuming they file their taxes as single and have no dependents.
There are four types of income-driven repayment plans available; Revised Pay As You Earn (REPAYE), Pay As You Earn (PAYE), Income-Based Repayment (IBR), and Income-Contingent Repayment (ICR). Eligibility for each plan may depend on your loan type, date, family size, tax filing status, and loan balance. Those interested should reach out to a licensed student loan counselor. They will be able to find the plans you are eligible for and estimate what your payment could be.
The other advantage of being on an income-driven repayment plan is that you can qualify for Income-Driven Repayment Forgiveness (IDRF), a program that will see your entire loan balance, principal and interest, forgiven. The length of this program can vary depending on the payment plans you are eligible for and the level of degree earned; however, it would be after approximately 240 qualifying payments. Once again, contact a student loan counselor for more information on your eligibility for this program. If you plan to keep another job while starting your company, you may be eligible for other forgiveness programs. If the job is in the public sector or 501(c)3 tax-exempt, a counselor may also determine your eligibility for another program called Public Service Loan Forgiveness (PSLF) that could see forgiveness in only 120 qualifying payments.
Forbearance and Deferment
Even after refinancing or changing payment plans, if you can see you will still fall into default, you may opt to use some general forbearance or deferment available to postpone payments. Private loans may or may not have forbearance available, and you will want to contact your lender to see if this option is available to you. Those with federal loans will have 36 months of forbearance to use to postpone payments on their loans. However, note that interest will still accrue on your balance during this time, and those months will not count towards any available federal loan forgiveness programs. If looking into this option, having a consultation with a professional student loan counselor can help you strategically plan your forbearance.
While it is undoubtedly scary and risky starting your own business, it is also just as, if not more, exciting and fulfilling. The statistics may seem daunting, but they should not be what stops the next generation of entrepreneurs. The key is taking action now to prepare for the future. As Benjamin Franklin once wisely said, “By failing to prepare, you are preparing to fail.”
