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Self-employment blues

Independence has its rewards, but easy credit isn't among them. Here are some tips for couples dealing with the vagaries of working on their own

Special to The Globe and Mail

After just two months of house hunting, Sarah Phillips and Sean Snell found the home they wanted to buy.

Getting a mortgage, however, was not as easy. Even with spotless credit histories, a down payment equivalent to 25 per cent of the selling price and a solid record of paying their rent on time, the Toronto couple could not persuade any of the banks they approached to lend them money.

Ms. Phillips, a theatre producer and director, sums up the problem in three words: "We're self-employed."

Ms. Phillips and Mr. Snell, a film special-effects technician, are part of a growing group of Canadian households in which both partners are self-employed. The latest available figures from Statistics Canada show that, between 1976 and 1998, the number of self-employed couples in Canada jumped to 334,000 from 154,000. Close to 70 per cent of self-employed couples in 1998 were running a business together.

While both being self-employed gives couples a number of advantages, from greater control over their work schedules to spending more time together, it also throws up a host of particular financial challenges.

"The thing that is most stressful is that, on any given week or month, we don't know what our income will be and whether there will be enough money to cover the basics," says Ms. Phillips, the mother of an 18-month-old girl. "So we're always dipping into our lines of credit and credit cards -- there's a lot of money shuffling."

In addition to not having stable or predictable incomes, self-employed couples must also deal with a lack of access to employer-sponsored health and insurance plans, unemployment insurance and paid parental leave. And when it comes time to borrow money, financial institutions may not be as forthcoming as they are with those on a company payroll.

Renee Talavera-Siao, a Toronto-based financial adviser with Assante Financial Management Ltd., says she understands how difficult it can be to budget and save when self-employment typically brings cycles of feast and famine.

Instead of a typical budget, she encourages self-employed couples to create a cash-flow statement, essentially an ongoing log of monthly income and expenses.

"That's how you can start getting a clear picture of your spending and income trends and what you're actually doing," she says. "And once you understand these trends, then you can start working on a budget."

Terry Sukman, a Toronto-based financial planner with Investors Group Inc., says one of the first things self-employed couples must do is build a cash reserve large enough to cover six months' worth of bills.

"When you're going freelance or starting your own business, you need to create your own safety net," Mr. Sukman says.

Ms. Talavera-Siao suggests diverting at least 10 per cent of income to a savings account to create forced savings. "And every time you take money out of your reserve, you need to factor that amount as an expense in your next month's budget because you have to put it back."

Ideally, she says, couples should build a cash reserve before they trade in their jobs for self-employment. It's one way to help avoid another common pitfall for the self-employed: living off credit cards and lines of credit.

For those who must use them, Ms. Talavera-Siao advises paying down high-interest credit cards as quickly as possible and using credit lines -- which come with lower interest rates and require interest-only payments -- to carry balances in the future.

But even getting approved for credit can be tough for self-employed couples. Mr. Sukman's suggestion? "Get your loans, mortgages and credit lines while you're still working for an employer . . . It is something you have to plan for in advance."

For couples who don't have the luxury of securing financing beforehand, and who are having problems getting banks to lend them money, Mr. Sukman suggests approaching credit unions, mortgage brokers or even their lawyers. The latter, he says, can often arrange private loans between their clients and wealthy individuals.

For homeowners, home equity lines of credit, which use equity in the home as collateral and charge interest at prime, can be a good idea as a source of money or to take the place of a mortgage, says David Fallon, an associate vice-president at TD Canada Trust.

To buy their home, Ms. Phillips and Mr. Snell ended up arranging a vendor take-back mortgage, an agreement where the person who sold them the house essentially financed their mortgage. Two years later, Ms. Phillips and Mr. Snell got approved for a mortgage with TD Canada Trust. The bank also gave them a line of credit.

"I guess we were able to prove that we are able to make the mortgage payments," says Ms. Phillips. "Plus our credit ratings were really good to begin with."

The couple's new mortgage was also likely a result of recent changes in many banks' lending policies and attitudes toward the self-employed.

The Canadian Imperial Bank of Commerce, for example, has just come out with a "self-employed recognition mortgage" that makes it easier for those working for themselves to buy a house.

In the past, CIBC required financial statements for the last three years and prospective home owners had to come up with a down payment of at least 35 per cent. With the new mortgage, CIBC asks only for a declaration of income and, providing the applicant's credit rating is good, will lend up to 75 per cent of the total purchase price.

"People are coming to the realization that this part of the population is growing," says Paul Mims, vice-president of marketing and sales for CIBC's mortgage division. "What we're saying with this mortgage is that we recognize [self-employed people] as good customers."

Most financial planning experts agree that a self-employed couple's safety net should also include life and disability insurance, as well as health-care coverage.

At the very least, they need to cover things like prescription drugs and dental expenses, Mr. Sukman says. "Even if you don't get anything else, get health insurance, because if you get sick, you won't have the opportunity to earn money."

Ms. Talavera-Siao says life and disability insurance are also a must. "In case one or both of you dies, you need life insurance to be able to cover your mortgage and credit card debts, plus at least 10 times your annual income," she says. "And you definitely need disability insurance because there are more chances of people getting disabled than there are of passing away."

She suggests term life insurance is the best way to go because it lets you buy a large amount of coverage at a low rate. And since most mortgages are spread out over a 25-year-period, she recommends buying coverage for at least 20 years. As for buying insurance, find out if any professional associations or your post-secondary institution offer group rates to members or alumni.

What about saving for retirement or a child's education? Ms. Talavera-Siao says that getting a cash reserve in place and the business stable come first. After that, one way to kickstart retirement savings is to take out an RRSP loan and use the tax refund that may result from an RRSP contribution to pay back the loan.

As for kids' education savings, it's a good idea to open a registered plan as early as possible -- even if regular contributions don't fit into the budget -- and invite relatives and friends to make deposits as Christmas, birthday or other gifts. "The RESP doesn't have to come from just you," she says, "so don't take it upon yourself that you're the only one who has that burden."

© The Globe and Mail

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