A Freelancer’s Guide to Handling Debt Responsibly

That’s a pretty controversial statement for many people. Newspapers and websites are full of horror stories about people who got mired in debt, and also of inspirational stories about people who paid it all off. Debt is often presented as a terrible burden, almost like a chronic illness.
But here’s the thing: debt is a core part of today’s economy. Companies borrow money all the time, using it to invest in things like better equipment and faster growth. As a freelancer, you’re in business too, so why shouldn’t you do what successful companies do?
Of course debt can be dangerous. So can knives, but it doesn’t mean we don’t use them. The key is knowing how to handle them.
So in this tutorial I’ll teach you how to handle debt responsibly. You’ll learn how to get the right type of loan with repayments you can afford, and then how to pay off your debts efficiently. You’ll learn how to avoid some of the common mistakes people make with debt. By the end, you’ll feel less scared and more confident in your ability to handle debt without inviting financial chaos.
You may still decide you want to steer clear of debt, of course, and that’s a valid choice. But at least you’ll be equipped with some extra knowledge so that you can make an informed decision about what’s right for your freelance business.
The first step in handling debt responsibly is to borrow for the right reason.
People often get into trouble with debt because they borrow to cover up a fundamental financial problem. They’re spending more than they earn, so they can’t pay their bills, so they resort to credit cards or other debt to keep the lights on.
If you’re spending more than you earn, you have only two sensible choices: earn more, or spend less. Borrowing to cover the shortfall simply allows you to continue with unsustainable business habits, and adds on a lot of interest payments to your existing costs. It’s a short-term fix, but in the long term it just puts you deeper in trouble.
So what are good reasons for wanting to borrow money? Here are a few examples:
All businesses have startup costs, and freelancers are no exception. Because you don’t have employees and usually don’t need special premises, those costs are often small, but they exist. Even if your business doesn’t require complex equipment, you’ll at least need a computer, and probably some specialized software. A website is a pretty basic requirement too, and that costs money.
Certain types of freelancers may have much larger startup costs to worry about. If you’re a photographer, for example, you may need to spend several thousand dollars on buying a high-end camera, tripod, flash, lights and other equipment. You may need a special studio space, or a car to be able to travel to events. If you don’t have a lot of money saved, borrowing money to get started is an option.
I’m writing this on a 2011 MacBook Air. As a freelance writer, I’m lucky that I don’t really need much else in the way of equipment, but I do know that if anything goes wrong with it, I’ll need to get it repaired or replaced very quickly.
Since it’s a predictable expense, ideally I’d have money saved in my emergency fund (see my budgeting tutorial for information on that). But if I don’t have enough saved, debt would be a better alternative than going out of business.
As freelancers, the fundamental thing we sell is our expertise. And whatever field you’re in, you can bet that at least some of the expertise you have right now will be obsolete a few years down the line. We have to stay up-to-date; constant self-improvement is a condition of doing business.
Luckily there’s a lot of free information on the internet, but sometimes you also need to invest in your own future. In some fields, you may need a particular qualification, or having it may help you to win more business.
In that case, borrowing money to invest in improving your skills could be a sensible choice. Of course, you still need to do it right, and we’ll cover that in the next sections.
Often when people are looking for a loan, they ask, “How much can I borrow?” That’s the wrong question to ask. That puts the onus on the bank to determine your own financial needs. If they’ll let you borrow $20,000, you borrow $20,000. It shouldn't be a surprise to learn that letting someone else make your financial decisions is a bad idea.
Instead, the right question to ask before you touch any form of debt is, “How much can I afford to borrow?” The reason many people don’t ask this question is because it can be quite difficult to work out an accurate answer. So in this section, I’m going to show you how to do it.
Before you apply for a loan, you need a firm grasp of your financial situation. A freelancer’s income can fluctuate, but you need to know your average monthly income, and have a realistic, accurate picture of your average monthly expenses.
If you don’t know these numbers, I take you through exactly how to come up with them in my Freelancer’s Guide to Effective Budgeting. It’s important to note that your “expenses” need to include not just the cash you spend each month, but everything, including money you’re putting aside for future tax bills or other major items, and money you’re using to make payments on existing debts.
Let’s say that you have a clear budget, and your figures are as follows:
  • Monthly income: $2,000
  • Monthly expenses: $1,750
In that case, you have $250 available to make monthly payments without blowing your budget. But how much loan does that get you?
The answer it that it depends on the term of the loan (how many months or years you take to pay the money back) and the interest rate. You can play with some different scenarios by plugging numbers into the loan calculator at Bankrate.com.
Using the calculator, you can see that if you borrow $10,000 for 5 years at 10% interest, the monthly payments will be $212.47, which you can afford. But switch the term to 2 years, and the payments balloon to $461.45, which would quickly put you in even more debt. So adjust the numbers based on your requirements, and based on the kind of loan terms you think you can get.
The scenario above is great, but of course many of us don’t just have an extra $250 lying around at the end of each month. So what if you don’t have enough money left to make payments on the loan you need?
Then you’ll need to make adjustments to your budget. The first thing you can do is to look at your expenses, and see if there are any cuts you can make. The important thing is to be realistic: don’t plan to cut out your entire entertainment budget, for example, and then find yourself unable to stick to it later on.
Another option is to find ways to earn more money. It could be as simple as searching for more assignments, or asking existing clients for more business, orraising your rates.
If you expect your income to increase as a result of the investment you’re making—for example, if you’re buying equipment or taking a course that will enable you to get new clients—then you could budget for a higher income in the future, but be very careful about making assumptions. Optimism is generally a good trait for freelancers, but when you’re budgeting for the future, it’s better to assume the worst. It’s better to be too cautious than to take on a loan you can’t afford to pay back.
If you want to borrow money, there are plenty of different options. Choosing the right type of loan is important, so here’s a quick guide to some of the main types of debt, and their pros and cons:
Borrowing money doesn’t have to involve going to banks and paying costly interest rates. If you have friends or family members who are in a position to lend you money, that’s a great option. The downside is that if things go wrong and you struggle to pay them back on time, you could ruin a good relationship. Or what if they suffer a financial crisis and need the money back earlier than expected? There’s a good reason for that saying about money and friends not mixing.
This is perhaps the simplest way to borrow money. You probably have one already, and if not, it’s very easy to get one in many countries. A credit card gives you lots of flexibility to borrow as much as you need and pay it down as you are able. But interest rates can be very high, and the very ease of using credit cards can easily entice you into borrowing more than you can afford to pay back.
These are similar to credit cards in that you are given access to a certain amount of money, and pay interest on any funds you use. They can be harder to acquire than credit cards, however, and the fees for using the line of credit can sometimes be high.
Unlike “open-ended” credit cards and lines of credit, term loans are for a fixed period, and usually have a fixed interest rate and repayment schedule. That means that you know exactly what you’re getting into, but they’re not as flexible as credit cards or lines of credit. Term loans can sometimes be secured on a particular asset like a car, meaning that if you default on the loan, you lose the car. Unsecured loans are also available.
This is a more recent option. The idea is that you bypass the banks and borrow from other people who sign up on a website as lenders. Examples would be Prosper andLending Club in the U.S., and Zopa in the U.K. Rates can be lower than with the banks, although it depends on your credit rating and the terms of the loan, so still shop around for the best deal.
These are very short-term loans, designed to get you through a quick cashflow crisis. Rates can be eye-wateringly high, though, so it’s generally best to avoid theseunless you have no other option.
When you've decided on the type of loan you want, it's time to research what's on offer. Of course, rates and terms can vary hugely, so it’s important to make sure you’re getting the best deal.
One important thing to keep in mind is that the terms you’re offered can depend to a large degree on your credit rating. So do your best to ensure that you stay on top of all your existing obligations. By doing so, you should be able to get a lower interest rate on future loans.
Also check your credit report if possible, to make sure it’s accurate—a 2013 studyfound that 40 million Americans had mistakes on their credit reports. In the U.S., you can get free credit reports from AnnualCreditReport.com.
Also ensure that your finances and record-keeping are professional. If you’re going to the bank for a loan, they may want to see some details about your income and expenses, and it’s best to be as business-like as possible. If you can show convincing, accurate, detailed metrics going back several years, you will give any lender a lot more confidence in your ability to pay the money back, and may be offered better terms as a result.
Once you’ve got everything set up, it’s always worth shopping around for the best deal. Look at different providers, and even check out different options from the same provider. Comparison sites like MoneySupermarket (in the UK) can help you find good deals, so look for similar sites in your country.
Choosing a loan responsibly is a big part of the story, but handling debt responsibly also involves paying it back as quickly and effectively as you can.
You’ll need to work carefully within your budget, placing a high priority on making the required payments on your loan, and allocating more money as available to paying down the balance. Here are a few more strategies that can help:
If you have several different loans, list them in order of interest rate, with the highest at the top, and focus all your energy on paying off the loans with the highest rates first, while paying just the minimum on the loans with lower rates. For more details on this process, and how to fit in debt repayment with your other financial goals, see Section 2 of my tutorial on saving and investing for freelancers.
Have you picked up the phone to ask your bank or credit-card company for a better rate? It’s an often-overlooked strategy, and it doesn’t always work, but sometimes you can get much better terms simply by asking. This article has some good tips on negotiating successfully.
If negotiating doesn’t work, another option is simply to search for a provider that offers better rates, and transfer your balance over. This works especially well with credit cards. Just be sure that you stay on top of things, and don’t end up with even higher rates after the generous introductory offer expires.
You can sometimes consolidate several different loans into a single one with a lower interest rate. You need to be careful, however, because some debt consolidation companies simply charge high fees and can make your situation worse.
There are also legitimate debt consolidation loans offered by banks and credit unions, but even then, do the sums to make sure you’re actually improving your situation. Consolidating can have potential downsides.
If handled badly, debt can be a blight on your freelance career, saddling you with unnecessary fees and interest payments, and in extreme cases even putting you out of business.
But if you borrow wisely, you can use debt to invest in your freelance business, acquiring equipment or skills that you would have had to wait years for if you’d been saving up.
The key points are to borrow for the right reasons, to have a clear idea of how much you can afford to borrow, to choose the right type of loan at the best possible terms, and to manage the repayments intelligently.
If you can do all of that, using the strategies we’ve covered in this tutorial, then you don’t need to be afraid of getting into debt. You can view it as just another financial strategy available to you as a freelancer, and you can be confident in your ability to handle it responsibly.
Graphic Credit: Credit Cards icon designed by Martha Ormiston from the Noun Project.


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