Credit Scores and Ratings for Freelance and Self-Employed People
It's no secret that self-employed people have more hurdles to clear when applying for mortgages, car loans, credit cards, or other financing. In particular, mortgage application procedures have tightened since the mortgage crisis, and products such as low-documentation loans, which once enabled many self-employed freelancers to get mortgages, are no longer offered. In this economic climate, credit scores and credit ratings have become more important than ever, especially for mortgages for self-employed business owners.
Clean Up A Bad Credit Report
Many credit reports are littered with small mistakes, with errors such as addresses where you've never lived and employers you've never heard of. This can be especially true for self-employed creatives who often spend time couch surfing when beginning careers in expensive cities, or who travel widely and use a friend's address for correspondence and bills. Unless there is negative information on a credit report, these small errors usually don't impact a credit score. But correct them anyway: Having accurate information on file prevents misunderstandings.
It's even more important to correct erroneous information such as a debt that doesn't exist or a legal judgment that never happened. These are the kinds of issues that can derail a credit application, and you'll need to write to each credit reporting company, and then you'll follow up to be the corrections have been made.
The three major credit reporting agencies are TransUnion, Experian and Equifax, and they have to (by law) give you a free credit report once a year.
Debt-to-Income Ratio and Available Credit
Your debt-to-income ratio is the amount of money that you must pay every month to repay loans compared to your income. Most mortgage companies have caps on how high this ratio can be. For example, a lender with a 35 percent cap may be willing to lend you up to 28 percent of your income, assuming that you have no more than 7 percent of your income tied up in other debt. But if your student loans, car loans, and credit card debt add up to more than that, the amount of money they will be willing to lend goes down.
Available credit is a tricky category. On the one hand, you want enough available credit that your existing debt is only a small portion of what you could be borrowing. This send reassuring messages to a potential lender that you don't run your expenses up to the hilt and are a responsible borrower.
However, if you have too much available credit, that can send warning signs to the lender that if you wanted, you could buy a put a Porsche and a diamond ring on your credit card, run off to Tahiti -- and then have trouble making your payments to them.
Segregate Business Expenses From Personal Expenses
It's easier from a tax standpoint and a personal budgeting standpoint to segregate all your economic activities that involve business from your personal finances. This means separate bank accounts, credit cards, and receipts.
Of course, for self-employed people this is easier said than done. Say you are hosting a party for your clients, and you buy paper plates and cups at the grocery store. If you throw some food for your own dinner into the same cart, do you have to ring up two separate times? Purists would say yes. Of course, it's possible to circle all the items you bought for business, tally them up, and keep the receipts -- but it leads to confusion and can be a source of mistakes.
Keeping your records neat and separate will make life easier for you at tax time, and also may smooth the way to a loan if large business expenses are pulling down your declarable income. Being able to show a lender that your business operating expenses are sound may be the missing piece of information that makes a loan officer say "yes."
Keep Stable Credit Cards Accounts
Having lots of new accounts reduces the average age of your credit accounts, and hence lowers your credit rating. Sure, it makes no sense. After all, the reason you're getting all those offers of new credit cards is because you've moved up in the world, right? Well, not according to the FICO statisticians. They've determined that the people most likely to pay back debts are the people who have had the same old credit cards for a million years. Canceling accounts to trade up for more frequent flyer mileage (or whatever the latest offer is) is okay once in a while, but don't make a habit of it if you're concerned about your FICO score.
Your FICO score is a number somewhere between 300 (terrible) and 850 (you are so perfect you probably don't need to borrow money). For the best rates on loans, your score needs to be 750 or better. While a score of 700 is often acceptable, self-employed borrowers are starting any loan application with the deck stacked against them. Some attention to your FICO score can pay big dividends in faster approvals and lower interest rates.