Unsteady income? Traditional debt-paying advice doesn't apply
By Dawn Papandrea | Published: October 4, 2016
Much of the traditional advice you read about paying down debt is based on the assumption that you have a consistent paycheck and fairly regular monthly expenses.
But for a good segment of the population, there’s no such thing as a steady salary. In fact, more people find themselves having to budget with irregular income. By 2020, the Intuit 2020 Report estimates, more than 40 percent of the American workforce, or 60 million people, will be working as freelancers, contractors or temporary employees.
“Debt is really more burdensome for people who don’t have regular income,” says Mike Sullivan, spokesman from Take Charge America, a national nonprofit credit counseling and debt management agency. That’s not to say that paying down balances is impossible – it just requires a different approach when you’re not certain how much your next paycheck will be or when it will arrive.
If you’re self-employed, rely on commission-based earnings or have joined the gig economy, here are some new ways to think about managing your debt load.
Some carry-forward debt is OK
While many financial experts are proponents of debt-free living, Terry Siman, managing director of United Capital, a financial life management firm, says that’s a lot of unnecessary pressure to put on yourself, especially when you’re not salaried.
Instead, he says, a more realistic approach is to go with the income flow. “When you have unsteady income, you want to make steady progress toward a longer-term result. What’s more important than being debt-free is managing the cost of your debt, and its relationship to your assets,” he says. “If your income is going to ebb and flow, your debt is probably going to ebb and flow as well.”
Don’t exhaust big paydays on debt
Although conventional wisdom says to use windfalls such as tax returns and bonuses toward balances, that’s doesn’t always apply in this case.
“It goes against the usual debt strategy to pay things off as rapidly as you can,” says Sullivan, “but let some of the debt ride if you’re not confident when that next check is going to show up.”
What’s more important than being debt-free is managing the cost of your debt, and its relationship to your assets.
Managing director, United Capital
When Carrie Smith Nicholson, a financial writer who founded CarefulCents.com, decided to go freelance, she had to adjust her money mindset. She’s tackled debt both as a salaried employee (paying off $14,000 in 14 months after her divorce), and as a self-employed entrepreneur (paying back business-related debt, but at a slower pace).
“I always tell freelancers don’t worry about the debt so much. Set up a consistent debt payment plan, but not as aggressive as you would if you were at a regular job,” she says.
What works for Nicholson when she has a big payday is moving the money into an account earmarked for debt payment, but not spending it all at once. She uses a portion of it toward her balance, and if it’s still there in couple of months, she’ll make another big payment.
What also works for some of Nicholson’s colleagues is aligning specific gigs with certain goals. “If you want to pay down a credit card, you might use all of the income from one extra project for that one goal. That can help motivate you,” she says.
Ramp up emergency savings first
You might have heard that if you’re carrying high-interest debt that it should be your sole focus, other than socking away a small savings of $500-$1,000 to help offset financial crises such as car repairs. However, for self-employed workers, a more substantial savings must come first, regardless of debt load.
“If there’s no steady paycheck, just a two-week delay on a payment can become disastrous if you haven’t prepared for that impaired cash flow,” says Sullivan. That’s why he recommends having at least three months’ worth of expenditures put away before you obsess over any credit balances, provided you’re making at least the minimum payments. Otherwise, writing out checks to creditors could become counterproductive since you’ll have to turn right back to the plastic – sans a rainy day fund – the next time your checking account is depleted.
I prioritize savings so much more now. The more savings cushion you have, the less chance you’ll have of getting into more debt.
Carrie Smith Nicholson
“I prioritize savings so much more now,” says Nicholson. “The more savings cushion you have, the less chance you’ll have of getting into more debt.”
Become a money micromanager
Sitting down once a month to balance the checkbook or tracking spending might work for most households, but those with less predictable income will have to keep a closer watch. For one thing, there most likely will be tax implications to consider since freelance income is typically not taxed upfront.
“People piecing together 1099 income need to be careful about what their tax liabilities are. If you’re having a good year, you’re going to owe come April 15,” says Siman.
Besides savings, Nicholson says she prioritizes quarterly taxes above almost everything else. When payments come in, she multiplies it by her tax bracket (around 30 percent), and transfers that amount over to a separate account before she’ll even touch it.
Sullivan recommends working with a CPA or tax adviser so you know how much you should be setting aside for your estimated quarterly taxes.
If your small business is growing or your last commission check was huge, it’s human nature to want to accelerate your financial goals. But resist the urge to spend like you just hit the lottery.
“Salespeople by nature, for example, are optimistic, but that works against you when planning an income,” says Sullivan. Instead, train yourself to spend and save more conservatively based on worst-case scenarios. Having restraint will help you come out ahead and eventually, you’ll reach your payoff goals, says Sullivan.
Keep your credit clean
Although maintaining a good credit score should be on everyone’s agenda, it can be even more consequential when you don’t have a steady income. That’s because lenders don’t always give equal weight to salaried and self-employed incomes, since the latter isn’t considered to be as stable. Therefore, they may look for a stellar credit score to help support your case.
“When my husband and I moved to Denver last year, I had to watch my credit score to make sure it was strong since we were applying under my name for a new apartment,” says Nicholson.
By planning for the long term and embracing a slow and steady strategy for your debt payoff, even those with income inconsistency can make financial freedom a sure thing.
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