It’s difficult to read the news online without reading about personal debt. Owing money, like paying taxes, feels like a shared American experience. Earlier this year, CNN Money reported, “Total household debt climbed to $12.58 trillion at the end of 2016,” which is the most it has been in a decade and is close to what the cumulative American debt load was before the 2008 stock market crash.
But sometimes our understanding of what “debt” is and our judgment of it, can be skewed.
Financial website The Balance explains that personal or consumer debt is what an individual owes, and it falls into two categories: credit cards (revolving) and fixed-payment loans (non-revolving). The first may have variable interest rates and is considered revolving because it is meant to be paid off each month. The second may have either fixed or variable rates and includes auto, student, and any type of personal loans. However, The Balance does not include mortgages in consumer debt because “mortgages are personal investments in residential real estate.”
Brandon Walters, loan officer at PrimeLending in Texas, seconds that and says that debt-to-income is what lenders look at when they determine if and how much to lend you. Ratios for some kinds of loans are allowable for up to 40-50%. Leanne Plancic, a financial consultant with AXA Advisors LLC in Bellevue, Washington, says that debt-to-income ratio “can be subjective and it depends on how much risk tolerance someone has.” She, herself, is conservative and she takes a conservative approach with her clients, working with them to make them as debt-free as possible.
People start, and grow, craft businesses in many different ways and with many different financing sources. Some people start designing furniture or knitting while maintaining a full-time job, using that full-time job to finance the side business at the beginning. Others, like Molly Hatch, work as full-time designers as soon as they complete their education. Hatch says in a recent CIA article that she has learned to ask for part of the money in her contracts up front to actually fund the designs. How you launch your business—part-time or full-time and with what financing means—matters in reference to managing debt, as does if you’re a single income earner or in a dual-income household.
But one thing applies to everyone: Plancic advises first and foremost when you launch a business to meet with a business law attorney to set up an LLC—a limited liability company, a corporate structure where the members of the company cannot be held personally liable for the company’s debts or liabilities.
Many people launch side businesses as themselves, such as “Jill L. Ferguson, painter,” without a business name or forming any kind of corporate entity, and that, Plancic says, “risks your personal assets.” She advises protecting your home, car, and anything else you own by creating an LLC (or S or C Corp if it makes sense for you).
Second, if you don’t plan to keep another part- or full-time job, Plancic recommends having more than six months of living expenses in savings. “You should always have between three and six months of living expenses in a cash account,” she says. “But if you are starting a business on your own with no steady income, have at least six months of expenses on hand so you have time to build your business.”
If you need money to grow your business, many options exist to secure financing. Some business owners borrow money from their significant others or family members or use personal credit cards to pay for the costs of expansion. Others seek personal or small business loans, or may use crowdsourcing or person-to-person lending programs (like Prosper.com or Kiva.org). Plancic recommends avoiding credit cards to grow a business because the finance charges are much higher than if you finance the same amount of money through either a home equity line of credit (if you’re a homeowner) or through a personal or small business loan.
Business News Daily suggests looking for a possible cash-ready partner: “You may not have the money to bankroll your business right now, but someone else might.” Leslie Tayne, a financial attorney, debt therapist, and author of Life & Debt: A Fresh Approach to Achieving Financial Wellness said finding someone with a ready cash flow can help you get more accomplished, sooner.”
As with any business planning, it is essential to look at the cost of expanding (including interest payment costs or taking on a partner) versus the projected income generated over the life of the repayment cycle. Understanding how taking on more debt could cost you credit points should be taken into consideration. Credit scores, according to CNN Money are derived using the following ratio: 35 percent from your credit history, 30 percent from your credit utilization ratio (meaning of the money available to you, how much of it are you using), 15 percent from the length of your credit history, 10 percent from new credit accounts (meaning have you opened a bunch at once), and 10 percent from your credit mix. Or as CNN Money says, “Not all debts are created equal. Credit bureaus make a distinction between credit card accounts versus student loans, car loans, and mortgages.”
You don’t have control over some of the components that create a credit score, like the length of your credit history. Whereas you may have control over other factors like paying off high-interest credit card balances in chunks as you are able, and always making your payments on time, without fail. And though it seems counter-intuitive, asking for credit line increases from your credit card companies can help your credit utilization ratio and boost your credit score.
Lastly, although it may be tempting to use profits from your newly expanded business to pay down personal debt, Tayne says it is crucial to invest the money back into the business to keep it going and growing, and so you don’t need to borrow money in the future. Once you have a steady profit, then you can take some of the money to pay down, or even pay off, your personal debts.
Jill L. Ferguson
Jill is the author of seven books, an artist, editor, entrepreneur and consultant. She is the founder of Women's Wellness Weekends (www.womenswellnessweekends.