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5 Ways To Avoid The Self-Employed Bad Credit Trap

If you’re self-employed, are you destined to have bad credit?  Looking at my client roster, you’d think so.

Over the course of my career I’ve helped self-employed people of all stripes with bill problems.  From the solo attorney with a $35,000 American Express debt to the taxi driver with tax problems, I’ve seen a ton of money woes when it comes to those who “eat what they kill.”

Over the years I’ve seen some common mistakes made by these entrepreneurs, and have come to realize that bad credit doesn’t come with the territory.

All you need to do is take these five common mistakes to heart.

They Don’t Keep Taxes Separate

When you’re self-employed, nobody’s taking out taxes on your behalf.  Therefore, you’re going to need to do it on your own.  The best move is to open up a separate checking account for your venture and put 50% of your income into it.  Do it as soon as you make a deposit into your main business account or you’ll be tempted to dip into the till.

Escrowing for your end-of-year tax debt is smart because you won’t end up scrambling every quarter to pay the government.  Cut the check and move on, avoiding those late filing penalties and the possibility that you’re going to pay your tax debts with credit cards or lines of credit.

50% is on the high side, but that shouldn’t cause you to reduce the amount.  Rather, you’ll get the equivalent of a tax refund each year.  Better yet, you can put the extra money towards next year’s amount due.

They Don’t Turn Credit Card Debt As A Fixed Loan

Self-employed people use credit cards to fund short-term operating expenses such as office supplies and utility bills.  Most often, the rationale is that using the credit card is good for accruing travel rewards and the like.

Nothing wrong with that, but if you’re using the credit card then you should be looking at is as a fixed loan in the amount of the total credit line.

For example, let’s say you’ve got a Visa card with a $20,000 limit.  Assume you’ve got a loan of $20,000 and figure out a repayment schedule that would pay off the debt in 5 years with interest.  Now you can use that payment amount as a budgeted expense each month, sending the payment into the credit card company regardless of what you actually owe at any given point in time.

No longer are you getting the statement and figuring out how much to pay – you’re paying the same each month.  You can use your card more readily now because the monthly expense is fixed and based on your “worst case scenario” of owing the maximum.

They Mix And Match Expenses

Your business is one part of your life, but not all of it.  Regardless of the size of your venture, you don’t want to pollute the financial waters by mingling personal and business income and expenses.  Keeping it separate also helps when you itemize your deductions each year for tax purposes.

They Forget To Check Their Credit Report Regularly

Your personal credit is important when you’re self-employed because every transaction is going to rely on it.  Opening an account with the postal scale folks, getting insurance for the business, equipment leases and the like all depend on what your credit report says about your ability to pay on time and meet new obligations.

If there’s an error on your credit report, you need to attend to it immediately.  One inaccuracy could mean worse business terms for you, which translates into more money out of your pocket each month.

They’re Too Optimistic

Self-employed people wear rose-tinted glasses.  That’s good because without optimism nobody would start a business.  But you’ve got to remember to temper that with some solid planning for the future.

Business may be great this month, but our economy is cyclical.  There are bound to be bad times, just as there will be good ones.  To hedge against the downturns, create a personal and a business budget focusing on the necessities as well as the extras.  Keep an eye out for what you’re going to need to keep the business going in tough times, as well as what you can jettison without compromising operations.

To that end, keep a backup plan at the ready.  If things go sour for too long, you’re going to want to know you can get out from under the weight of a failing business in an orderly fashion.  Know how long is too long so you don’t end up in a mess of red ink because you were optimistic in the face of a grim reality.

Image credit:  Stéfan

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By |April 16th, 2012|

About the Author:

I've been a consumer protection lawyer since 1995, working to help people end their bill problems. I'm a faculty member at the Student Loan Law Workshop, a nationally recognized speaker, and a long-time member of both the National Association of Consumer Bankruptcy Attorneys and National Association of Consumer Advocates.
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