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Think The Subprime Debacle Is All About
Housing? It Hurts Small Businesspeople Too
If you're planning to go into business for yourself in the
next year, you need to understand that the subprime lending
debacle might have a significant impact on your ability to
borrow not only for your business, but for your personal needs
as well.
Self-employed people with excellent credit find out very
quickly when applying for a mortgage or any other loan that
lenders find it hard to "verify their income." Even if
you show years of tax returns, invoices and copies of cancelled
checks, individuals working for companies that track their
income on a weekly basis for the IRS get a slightly better
review from lenders who like to be able to see assets and
liabilities that they can verify.
This doesn't mean you won't get a loan, but it may be a more
arduous process and you very well might pay more than a person
with a conventional job. You may be shifted into the
"low-doc" or "no-doc" pile, which refer to
low- or no-documentation loans that often cost the borrower more
but allow approval based on less proof of income.
No one should pass up a chance at entrepreneurship simply
because it might be tougher to get financing in a range of
areas. But it does call for extra financial preparation before
you take the plunge. It makes good sense to talk with a
financial planner as well as a tax adviser as you plan your
business. Your personal finances must be planned around it as
well. Some key issues to discuss:
Consider your real estate plans before you leap. If
you are happy in your current residence and believe you have the
best financing option right now, then be happy to keep that
situation in place. But if you want to downsize or refinance
your current mortgage, it is considerably smarter to investigate
those options before leaving your current employer for all the
reasons we stated above. However, with the slow real estate
market in most areas of the country, you need to take into
consideration the average time on market for homes in your area
before you list yours. It's pretty tough to start a business
with two mortgages.
Continue your retirement savings. It's very easy in
the first months of business while you're waiting to get the
rhythm of cash flow in the business going to say, "I'll
deal with retirement later." This is not just a mistake but
a ticket to disaster. With all the other important issues you're
committing to as part of starting a company, make absolutely
sure you allot funds for retirement savings each year and don't
miss those contributions.
Get your insurance options in place. Whether you
purchase health insurance through COBRA at your old employer or
whether you buy coverage on your own, get it in place before you
quit your old company, and make sure you analyze your needs
closely so your major health issues are covered.
Get disability coverage before you leave your employer.
This is a really crucial step because disability coverage you
buy is based on a percentage of current income. In the first few
years of a business, you conceivably will not match your current
salary, so you wouldn't be able to buy as much coverage as an
independent. Get that coverage in place now. You should be able
to specify the level of benefits you receive, up to 60 percent
or 80 percent of your income from work. (Insurers won't cover
100 percent of income, because they want you to be motivated to
return to work after a disability.) Generally, the higher your
benefit level, the greater your premiums.
Extinguish as much debt as possible. Whether you're
starting a business or working for a traditional employer, in
this new lending environment, there's a very common piece of
advice that all potential borrowers should share — pay off as
much revolving debt as possible. Higher-rate revolving debt at
more than 30 percent of a credit limit on an account will damage
a credit score, and borrowers with lower credit scores generally
get less attractive loan rates.
October 2007 — This column is produced by the Financial
Planning Association, the membership organization for the
financial planning community, and is provided by Don McCarty of
Financial Decision Partners, a local member of the FPA.
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