How does being self-employed impact your finances?

Taking the leap into self-employment and freeing yourself from the constraints of a corporate culture or the scrutinising glare of a micro-managing boss is the ultimate ambition for many workers. Self-employment is often considered an opportunity to turn your passion into a money-making business that allows you to create a flexible and fulfilling career. While working for yourself may be an aspirational dream, for those who have taken the plunge, the stark reality can be a wake-up call, especially when it comes to how being self-employed impacts your finances.

When considering self-employment, most people are savvy enough to know that they need to take day-to-day living expenses into consideration, ensuring they earn enough to pay their bills. They also understand that chasing invoices will be as time-consuming as doing the actual work and that they often have to take on multiple roles including marketer, financial director, administrator, CEO, along with doing the actual work for clients and customers. What many fail to consider is the long-term impact being self-employed will have on their personal finances. Not only will the security of sick pay and paid holidays disappear, but it will also affect your ability to purchase a house, take out a loan and potentially even how you save for your retirement.

Being self-employed does not in itself impact your credit score. However, fluctuations in cashflow can often occur when you are self-employed, and may sometimes lead to late or missed payments on credit – it is this that can lower your credit score. A lower score reduces your options for borrowing and may even increase the lending rates you are offered. However, if you have a good credit history, this will count in your favour and you will still able to take out credit cards and loans, but you may only be able to borrow a smaller amount or have to pay a higher interest rate.

Lenders traditionally don’t like risk. This means that the more secure your income is, the more likely that you will get accepted for credit and at the best borrowing rates.

For self-employed businesses, access to credit is important because payments from your clients are not always guaranteed on time or sometimes at all! And, while you wait for this income to be paid to your business, you still have to fund the costs of your overheads and those costs connected to fulfilling other clients’ work. Business credit cards offer an interest-free period and using these can be a bridge until your cashflow returns to a healthier state. Credit cards should always be considered as short-term credit and should not be used for extensive periods of time as a source of funds for your business.

If you do find yourself in the position of having unpaid invoices then you could opt for an invoice factoring service who will chase the outstanding amounts and pay you usually about 85% of the invoice value.  

Loans can also be a vital source of extra funds both personally and for your business, for example when buying a new car or vehicle for your business or needing to make vital improvements to your home or workplace. Again, you may find the effects of being self-employed impact your credit score and this can result in you being declined for loans or, if accepted, having to pay a higher interest rate. Usually, to be accepted for a loan while self-employed, you will have to prove you earn a minimum income through tax returns and bank statements, such as the Tax Calculation and Tax Overview (also known as a SA302) for the relevant number of years. Some providers require a set income per month (for example paying yourself a minimum of £800 each month) while others will require a minimum annual income. In addition to this, a good credit history with the ability to prove you are able to repay debt will also be required by many lenders.

Before the 2008 financial crisis, many self-employed and contractor workers used ‘self-certification’ to obtain a mortgage. This allowed borrowers to declare their own income without the need for lenders to prove they could actually afford it. These were banned by the Financial Conduct Authority in 2014.

The biggest difference with affordability rules is that now you will have to prove your income and outgoings. This means providing evidence of your business accounts, Tax Calculation and Tax Overview (also known as a SA302) and bank statements for expenses. In addition to this, to improve your chances of a successful mortgage application you will normally need a high deposit or already own a large amount of equity in your home.

While getting a mortgage may have become more difficult, fortunately, at the time of writing, there are a high number of mortgages available to those who are self-employed.

Those looking for a different form of financing may want to consider asset finance as an option. This type of lending can either help you purchase high-value assets such as machinery, equipment and vehicles, or for those who already own such assets, it allows you to borrow money against their value, with the asset essentially becoming a form of security for the lender. The latter is sometimes known as asset refinancing.

At one time asset finance was only really suited to larger business because of the levels of finance involved, but with it now possible to raise sums as small as £1,000, it’s opened it up to smaller businesses too. As such, this kind of finance can be ideal for self-employed individuals and sole traders who are looking to expand their business, but who don’t have the available cash to purchase the necessary – and often expensive – assets. It can be just as suitable for already established sole traders who don’t have much liquid cash available, and who may want to borrow against the value of their assets to generate a cash boost for the business.

You can find out more about by reading our guide to asset finance.

When you’re on the payroll of a company, usually your income tax and national insurance will be automatically paid for you from your wage, but as soon as you step away from being an employee and into self-employment you are on your own. This means you will need to complete a tax self-assessment and ensure that all the tax you owe is paid by the dates set out by HMRC. You should forecast your expected income and calculate your anticipated income tax bill for the tax year and then regularly save an appropriate sum from your earnings. Remember any savings you have are subject to the personal savings tax allowance, depending on your level of income.

You can read more about the personal savings tax allowance in our guide How are my savings taxed?. An option is to use a tax-free savings account and cash and stocks and shares ISAs allow you to save up to £20,000 each per tax year. Ideally, you should try to keep any savings in an ISA as part of your rainy day fund and not for expected bills as their tax-free status remains in place year after year.

As well as this, some of the benefits of being employed are sick pay, paid holidays and maternity/paternity leave. When you are self-employed you will have to pay for these yourself, which means having the money available for when these events occur. Again, a good way of ensuring you have the money you need is to plan ahead and start a savings pot that can be used specifically for holidays, maternity/paternity leave or in the event that you are too ill to work.

Although having savings to fall back on to help ease the pressure when these life events happen, also having self-employment health insurance and income protection will help to protect yourself in the event of illness or injury.

When you are self-employed it can be difficult enough coping with the day-to-day running of your business, along with meeting everyday finance costs, so thinking and planning about your retirement can seem like an extra hassle. Despite this, it is unlikely that a state pension will be enough to offer a comfortable income when you retire, which means having to pay into a personal pension regularly while you are working to build up a substantial amount to aid your retirement. There are a number of ways you can save towards your retirement, including investing in pensions, stocks and shares, property and savings accounts – but it is important to keep in mind that many of these options come with a risk attached, which is why it is a good idea to seek advice from an impartial financial adviser before making any investments.

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