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Perhaps you have heard of people using their students to pay for extras like fashionable clothes, fancy meals, international trips, and lots of things other than education. Maybe you know someone who has done this too. It can be tempting to “live the high life.” But have you heard of someone using student loans to start a business? You may have considered it yourself. Maybe you questioned if it is possible, or if it’s even legal.

student studying at a coffee shop

Image by Anastasia Gepp from Pixabay

Is it Legal to use Student Loans to Start a New Business?

It’s easy to overestimate college costs. But what if you discover you have school loan funds remaining? Can you use them for anything you want?

Technically, the loan agreement you have with the lender has the answer. In most cases, federal student loans come with detailed terms outlining what the money can and cannot be used for. However, private loans are usually a bit more open-ended. Of course, these stipulations haven’t kept borrowers from using federal or private school loans to pay personal expenses. One survey indicated that about 10% of student borrowers used loans just to pay for tuition.  Some of the things students used the funds for include:

  • 42% used student loan monies for food
  • 38% used the funds to pay bills
  • 33% used it to pay rent costs
  • 26# spent funds on clothing
  • 20% spent their money on traveling

Can Schools Track Spending of Student Loan Money?

It’s not feasible for schools to track how students spend student loan money. Unless students borrow more than just the cost of attendance, they have no clue if you are using the money for other purposes. Even then, they don’t have any way of knowing if you are using it for living expenses or living the high life.

Even though it’s not technically illegal to use student loan money for funding a startup, you’d be taking a huge risk. If lenders found out about it, they could terminate your student loan contract and take back their funds. You would also have to repay any of the loan money you have already spent. That would mean more monthly payments. You would also risk facing legal action from your lender and possibly the federal government. That would mean more legal costs, fees, and penalties added to your final bill.

Using your school loan money to fund your startup could have far-reaching repercussions. It’s a way better idea to raise startup funds some other way and use student loan monies as a last resort, if at all. If you feel there is just no other way to do it, take a look at these pros and cons for using student loan money for a new venture.

Pros and Cons of Using Student Loans for a Startup

Pros of Funding a Startup with Student Loan Money

Easier to Qualify. It’s usually easier for students to qualify for student loans than it is to qualify for other traditional business financing options. Lenders tend to have more lenient requirements for student borrowers.

Lower Interest Rates. Student loans usually have much lower interest rates than business loans, credit cards, or personal loans. This is especially true for students who either haven’t had time to build up credit or don’t have a great credit score.

Payback Times. The time allowed to pay back student loans is usually much longer than with traditional loans. You’ll also have more repayment options. Some lenders allow missed payments or grant temporary payment deferrals. Repayment usually starts after graduation. That means you don’t have an immediate payment like you would with credit card debts.

Cons of Using Student Loan Money for a Startup

Legal Issues. Using student loans to fund a startup or any other business reason is risky. If you were to get caught, you could face legal and financial consequences.

Increased Debt. You are likely to take on more student debt. This debt can follow you for years after you graduate. You’ll be budgeting monthly payments for it for years. Because of the interest that continues to accrue, you’ll increase what you owe over time.

Financial Obligation. If you don’t have the means to repay, you will still be held responsible for the repayment of student loans. Unlike business loans, credit card debt, and personal loans, student loan debt cannot be discharged by filing bankruptcy.

Reducing the Risk of Using Student Loans to Fund a Startup

Here are four tips for reducing your risk if you do choose to use student loans to fund your startup or other business venture.

1. Determine How Much Money is Needed for Your Startup

Creating a clear business plan will help ensure that you know exactly how much money is needed for startup costs. When doing your calculations consider these things too:

  • Credentials, licenses, and fees needed for establishing your business
  • The average marketing budgets for other startups in the same niche
  • Cost of obtaining inventory
  • Cost of setting up an online store and website
  • Money needed to pay contractors or employees
  • Budget for unexpected expenses
  • Other equipment, resources, and the software necessary for running the business

Knowing these costs helps you determine if your startup idea is profitable enough to take the risk of using your student loan money in the first place.

2. Reduce Your Living Expenses

Save money where you can such as on your rent, food, textbooks, and other expenses. Then you can put the money you save toward your startup or business. This helps reduce your total student loan debt. Keep your cost of living down, manage impulse buying, and sacrifice a few extras like entertainment. This can pay off big further down the road.

3. Find a Business Partner

Having a business partner who can help fund your startup can help lighten your load. They may also have access to other funding options. The best choice in business partners can also provide valuable industry-specific experience and expertise that is worth more than money in many cases.

4. Research Alternative Funding Options

Ideally, the best way to reduce the risk of using student loans is to avoid using them for business purposes totally. If you feel there is no other way, and the risk is necessary, consider it as supplemental to other financing options. Treating it as a supplement helps you use less loan money toward your business.

Other Ideas for Raising Funds for Startups and Businesses

Apply for Small Business Loans

The most straightforward means of getting a small business loan is going through the Small Business Administration. They provide reasonable financing options for startups.

Credit Cards

It’s easier to get a credit card than it is to qualify for a business loan sometimes. Using a credit card for startup costs can be a good resource. However, remember that credit card interest rates are usually much higher than interest on loans.

Online Lenders

Online lenders often have a faster application process than brick-and-mortar lenders. The downside is that they also usually have higher interest rates.

Employment Opportunities

Consider getting a second part-time job or seeking summer employment. Designate the extra earnings toward funds for your startup. Having an extra job also provides you with an opportunity to learn what goes into running a business. You can apply those lessons to your own business.

If you choose to use some of your student loan money for a startup, make sure to cover educational expenses first. If not, you may end up taking out more loans than necessary to cover the difference.

burden of student loan debt

Is Using Student Loans for Business Ultimately Worth it?

If you are a student and you have a great business idea that you are excited about, it may sound easy to use your student loans to cover startup costs. Make sure that it is the best move for you and your personal finances.

Student loan debt can be a huge financial burden that you’ll have to carry for years or decades. You may pay on them a long time after you graduate with your diploma. You also take a risk of getting caught using the funds for non-educational reasons.

Student loans are not the only way to finance a business. You may or may not have the good fortune of an angel investor who comes in to save the day. Just keep in mind that many people before you started successful business empires that began on a shoestring budget. This is your opportunity to rise to the challenge and prove what you are made of.