Credit for artists
Disclaimer: The world of banking and finance exists to profit from you and your decisions to the greatest degree possible in a regulated and competitive society. Its up to each individual to do thorough research, compare products and rates and fully understand the rammifications of their decisions. The following article is offered as insight and commentary on options that may be available to you, and requires the reader to take full responsibility for the use of given advice.
One of the big challenges for artists is dealing with cash flow issues. In a career where invoices may take months to be paid, the necessities of life cannot wait for your cheque to arrive. Freelance illustrators must develop budgets, strategies and tools to smooth the bumps of an unreliable income stream as well as have a long term plan for their finacial future.
Your bank is in business to take as much of your money as possible and reward you with as little as they need to keep your business. Your goal is to become aware of your options as a consumer of credit and to build your finances to a point where banks want your business because you reperesent someone who will hypothetically pay them secure and reliable profits in the form of interest, fees and consumption of their investment products. When the bank wants you as a customer you get better terms, when you are a potential liability, you get screwed.
Having an inconsistent freelance income can be a "feast or famine" situation, with famine being the more common state. Unfortunately, the default solution to cash shortfalls is often the use of credit cards to defer payments or even advance immediate needed cash. American consumers are $11.3 trillion in debt. More than $856 billion of this is from credit cards. The average individual credit card debt is more than $15,000 (US). The average annual rate is about 15 percent per year, and they run up to 28 percent. But when it comes to paying you on savings deposits, the same banks that issue credit cards are right in step with market rates. The average savings account rate is currently .06 percent.
If you’re only making the minimum payments on your cards, you’re going to end up spending loads of money on financing charges. For example, if you put a new $1,000 plasma television on your credit card which has an 18% interest rate and you only make the minimum payment of 2% or $10 (whichever is greater), it would take you almost 20 years to pay it off. You would have spent $1,931.11 in interest payments on top of the television.
We've all heard the phrase "the rich get richer, the poor get poorer". Cultivating good credit is a factor in fiscal health, while bad credit is a sickness difficult to overcome. The keys to building good (and cheaper) credit are building an asset base and a history of successful loan repayments. These 2 factors give a bank tangible means with which you can work together to lower borrowing costs. How you get collateral for a loan is generally having tangible assets that can be used as security by the bank (property, investments, GICs (term deposit). Your equity in a property (the amount it's worth minus the amount you owe on it) is a real monetary figure that proves to your lending institution there is value to back up a loan. Additionally, having some investments and savings proves that there is a history of budget discipline or employment with funds to back up any default situation, allowing your bank to recover what is owed to them.
Property ownership is generally a good way to build an asset base. In today's competitive and low mortage interest rate market, the interest costs on housing are at historic lows. Mortage debt should be thought of as different from credit card debt. In the case of a house, you are buying an asset you can’t generally purchase for cash. You also expect this asset to increase in value over the long haul. So, while you pay interest on this purchase, you may own an asset that increases more in value over time than the interest you are paying. For example, take a $250,000 house that you purchase with a $50,000 down payment. If you have a 4 percent mortgage, your interest payment on the loan the first year will be just under $8,000. If the value of the house goes up 5 percent per year on average, it increases by $12,500 the first year. So this isn’t a bad investment decision. And you get to live in and enjoy the home for the year. Furthermore, if you own a house, you also own a studio space and you can fairly deduct a portion of your house expenses as a business expense. Moreover, the monthly payment is set for the term of the mortgage, and gradually pays it off. Car loans work basically the same way; payments are the same for the term of the loan because all interest has been figured in from the beginning. This is in stark mathematical contrast to the compounding interest of credit cards, which could literally have no end because you are paying interest on your interest on your interest, ad infinitum.
The way to work towards property ownership is savings for a down-payment. Living frugally and saving consistently from a job when you are young and targeting slow-but-steady asset-building will help you build a foundation for leverage, reduced interest costs and borrowing options.
It will be easier to obtain a mortage when you are in a situation of employment, with a history of consistent income, rather than approaching lenders as a freelancer without income certainty. A two income household will qualify much easier than a single freelancer without a paper-trail of paystubs. Approaching your bank for financing while you are a freelancer will require better proof of your ability to service the loan, including tax returns, investment statements and proof of savings. You may also need contracts, invoices, paypal histories, and any other paper trails which show a (preferably increasing) income. The key is consistent income, so if you plan to embark on a freelance career, it will be better to apply for a loan before you make the jump and can show such consistency. Buy an affordable property, only what you need, and move up the property ladder in steps. It will be easier to get a loan on a cheaper property and you will spend less on interest. You will have the ability to fix up/improve a cheaper house and benefit from upsizing through appreciation rather then jumping into a larger house straight off and bearing all the cost through interest financing.
Once you have equity in a property, based on what you have paid into it and how its value has risen, the next step may be to get a HELOC or Home Equity Line of Credit. This is essentially a permanent loan, at an interest rate far lower than a credit card, that will allow you to tap into and access funds whenever needed. Traditionally, the HELOC was intended to be an instrument for very occasional, larger expenses like renovations or education. Over-use of home equity lines of credit played a large part in the recent sub-prime mortage crisis, as people started to use this easily-accessable credit to fund unnecessary luxuries; falsely assuming that perpetual increases in their home's value would outpace the dwindling effect of spending their home's equity thru these loans. HELOC lines of credit must be used with discipline, otherwise they can negate the point of growing wealth through house value appreciation. Its best not to borrow money, but if you have to you want to access the cheapest interest rates you can.
Interest rates on lines of credit are floating, meaning they vary from month-to-month based on the prime rate. Variable interest rates may be expressed as a percentage above or below prime rate, IE prime plus 1 is 3.25% (current US prime rate) plus 1% or 4.25%
A HELOC appears on your internet banking page just like another account, and you may get cheques for it like a regular account. You will be required to make a minimum payment monthly, based on the amount outstanding. The reason why a bank allows you to have this permanent low-interest loan is because it is secured by your asset (house), and thus fully repayable if in an extreme circumstance the bank takes possession of your property in default. Obviously you want to be responsible with all credit, even low interest, secured credit. The point is not to abuse and diminish your equity, but use it as a tool for smart borrowing; for when the cost of borrowing (interest rate) is less than the benefit you may achieve from those funds. IE: you will want to draw from your 5% interest HELOC to pay your 18% credit card bill.
Interest on money borrowed for investment purposes is tax-deductible. Eventually you want to earmark your HELOC interest (already a low rate) as being a loan that has been used for investment savings. Thus your minimal interest payments are also now tax deductable, making use of the HELOC indeed very cost-effective borrowing. Tax-deductilibility of other types of interest (IE mortage, student loans) varies from country to country. Get an accountant and get a plan.
How to get into a position of manageable debt costs:
If you currently have multiple loans, credit cards and large interest payments, you need to have a plan to pay off your debts. Without a property and assets to secure a line of credit you need to employ other tactics to get out of debt and reduce interest charges. Under the "Snowball Method" approach, you continue making minimum payments on all of your balances, except the one with the highest interest rate. You’ll devote the majority of your budget to that costly balance until it’s paid off, and then repeat to tackle the next highest rate.
If possible, always pay more than the monthly minimum requirement. When you’re struggling financially, it may seem impossible to squeeze out any more than the minimum required credit card payment each month. Paying only the minimum, however, lengthens the process of eliminating your debt. A better option is to find expenses within your budget that can be cut and put that money toward your credit card payment. Habits like eating out or making coffee trips can really add up. Those small sacrifices can really aid in alleviating your credit card debt.
If you have a credit card with a balance, you can often transfer your balance to a different bank/card if a "teaser" low interest rate is offered to get your business. This can give you a number of months to protect your balance at a lower interest rate while you work to pay it off. Just be wary of transfer fees or other tools the bank/card may use to compensate for lost interest profit and negate the benefits of moving.
One of the easiest and most effective ways to manage your cash flow and reduce your debt is to consolidate your various loans, lines of credit and credit card balances into a single loan with a set repayment schedule. By consolidating debt, you could save on interest costs, you will have just one payment to make, and you may find it easier to pay off your debt more quickly.
When you’re completely debt-free, you can allocate the entirety of your debt/interest budget to savings, focusing on building a downpayment for a property, or saving for another asset. We need to end our overspending habits, reclassify certain luxuries that have become known as necessities and start saving some money. If you are young, life will inevitebly get more complicated and expensive, so start being finacially responsible now and use the time you have on your side to turn small steps into big leaps forward.
There are further options available to finance property and pay off credit card debt, but these programs vary per country and will require you to research and discuss their benefits with your banker and accountant. For example, you may withdraw funds from your RRSP (Canada) and 401k (USA) to fund a home purchase or pay off debt. The limits and rules of repayment vary per jurisdiction, but these are possible routes to access funds that are pre-tax or employer-matched and thus may allow you to save for a downpayment faster.
Finally, it is generally very beneficial to have an accountant. A trusted professional who can unemotionally compare the mathematical impacts of decisons and advise you on options is invaluable. Each country will have its own tax laws and rules, and your accountant can help you access beneficial programs and plan for multi-year strategies. Accountants' fees are usually tax-deduductible.
The PACT Team
The PACT Team is here to help.