how America loves entrepreneurs

No, really.
As I’ve written several times, I’m constantly amazed at the roadblocks thrown up in the path of entrepreneurs in America – supposedly the birthplace of the self-starter.  If it’s not health insurance – my favorite bugaboo – it’s something else.  Just recently I learned about one more stumbling block:

Friends of my relatives have this story to tell. They  live in the northeast, and they have grown tired of the pressure of daily life in a crowded metropolitan area.  They have one child with another on the way, and the same concerns about the cost of living – education, food, commutes, etc. – bore down on them.  For months they have been preparing to move to another state where they planned to open their own business, the same business they currently run in their city – they have a good business that has been a profitable living for years.  They currently own a house which they plan to keep and rent out.  They also own another property which is rented out.  They have a solid business with a good history of earning income and a solid net worth.

I don’t know them well.  I’ve only met them a couple of times.  As far as I know, though, they are careful, prudent, and not overextended.  They had all the details worked out about their business plan for their new location.  They found a house, applied for a mortgage (for which they had a more than adequate cash down payment, even though they were not selling their current properties).  The mortgage was denied.  The only reason given is that they are self-employed. Even though they’ve been successfully self-employed for years, they will be newly self-employed in their new state, so there’s no income history there.  They are devastated, depressed, and feeling trapped.  For now, they are resigned to staying where they are.  They aren’t willing – as we were – to rent.

The system pushes back against people who don’t conform to a corporate ideal:  the worker for a big company who has a “safe” job. I can’t see why someone with a track record of years of self-employment income would be deemed a mortgage risk, but they are.  I imagine – although I’ll put it to the test soon enough – that I’d be more likely to get a mortgage as an employee of a big corporation than they would be as far more successful entrepreneurs.  I’m sure if I work in the financial services industry it would seem like a better job with a “secure” income – even after Lehman, Citigroup, AIG and all of the other disasters of the past year.  I would also be willing to bet that I’d have an easier time getting a mortgage after working for a corporation for 3 months than I would after working as an independent consultant for two years.  Why?

I know there are reasons for these types of barriers. Banks are – and definitely should be – able to set their own risk comfort level.  I’d hate to see too much government control over banks’ ability to loan – or not loan – for riskier groups.  Then again, that was the whole purpose of Fannie Mae – for that quasi-governmental entity to absorb some of the risk of lending from private companies.

This story is an anecdote, and I don’t have all of the facts. Nonetheless, it does demonstrate that there are challenges on top of challenges for someone who wants to strike out on their own:  heavier tax burdens (self-employment tax), discrimination against “non-safe” or “non-stable” self-employment income and the difficulty of obtaining health insurance for a self-employed individual.  As plonkee commented on a recent post here:

I’m surprised anyone that’s single is self-employed in the States because of the healthcare / insurance issue. It’s notable that most or all of the Yank pro-bloggers are married, and the majority of them are married to people who work in the public sector (school teacher, crime lab scientist,military, etc). [link]

That includes any single-income family like mine, too, not just single people. People still do take the leap to become successful on their own, but as plonkee points out, it’s a lot easier when that self-employment income is backed up by a spouse with a “real” or “safe” job.  I wonder how many families in America have a parent who would love to launch their own business, but shy away in fear of the consequences.  I know that’s what risk means, and that some people take that risk.  But it’s a shame that home ownership and health insurance are the things those people risk losing, because for some of us, that’s too much to lose.

photo credit: Old Sarge

20 comments

  • I wrote a whole post about how Job Security is a myth for me.

    I'm self-employed, and I (could, if I worked 12 months a year) make 4x as much as I did before. But no one acknowledges that it's a worthy job because they think you have to work 12 months a year, instead of 3-4 a year (which is what I'm doing to live for the entire year)

  • Why don't they just rent a place in NC (they could rent a house) and move and get settled and then buy a place once their practices are established. It seems pretty foolish to resign yourself to staying somewhere you don't like. ( I grew up in Staten Island and work in Brooklyn (in a family business) and you couldn't pay me to live in any of the 5 boroughs!) It sounds like the mortgage company made the right decision. Just because they have enough cash doesn't mean they will be successful in NC. My sister-in-law lives in NC and its a completely different animal than NYC.

  • Be self employed and give banks the appearance of corporate life. Start your own company (LLC filing as an S Corp) and pay yourself a salary. With documented W2 income you give banks the appearance of fitting the norm and you get to maintain your life as self employed. It also is a great way to reduce your tax load coming from Self employment taxes.

  • Scott – that is exactly what my family does here. When I have to get a mortgage its never an issue because even though I am technically self employed I still get a salary and a W2 through the S-Corp. Whenever they ask me if I am self employed I say sort of – but then they always tell me that I am not considered self-employed to them because I get a salary and a W2.

    • Sounds like you got some good advice or did some good research. One of the things I have found with most self employed people is that they have excellent skills and abilities in what they do.. but usually don't have a strong foundation in business structures, taxes and building wealth. I strongly believe everyone should be a business owner – not self employed. Might be just semantics to many people but words do have power and it makes a huge difference in how you approach your business and your future.

  • investoralist

    Interesting, as I've just come across an Atlantic article that talked about the forgiving attitude of Americans towards bankruptcy. But reading your account, and given all these hurdles placed in front of entrepreneurs, particularly the issue of health care, I am surprised that any go for it at all.

    http://www.theatlantic.com/doc/200906/bankrupcy

  • Not sure if your example really fit the post (which was good). The idea of not moving just because they have to rent is pretty lame – methinks they don't really want to go.

    • @Four Pillars: You're right – I think they are just people who don't want to rent. It's not part of the way they think: you NEED to own. But you're right, truly motivated people would adapt and overcome.

      It still bums me out, though. I'm willing to rent for a while, but I would like to own eventually.

    • @Four Pillars: I actually found out why they want to rent, by the way – they wanted a home office, and for their line of work a home office requires extensive renovations. Obviously a rental wouldn't fit the bill. Still doesn't mean they couldn't work around it if they wanted, but it does make it a bit clearer to me, at least.

    • So renting commercial space for their business is off the table? Renovations & customizing are expected w/commercial property.

      As was already said, sounds they really don't want to make the move and are making an excuse, or aren't willing to make any sacrifices e.g. live in an apartment and rent comm. space.

  • I would love to be self-employed, but the lack of benefits and the difficulty in getting a mortgage based on self-employment income is a substantial obstacle. I'd love to see some changes in “the system” but which changes and how they would occur, I can't say. I know it frustrates many people though.

  • Chad @ Sentient Money

    @ Wealth Squad and Lynn
    Gaming the system like this got us in the current mess. I'm not saying that using an LLC/S Corp is as bad as what a lot of people were doing, but it is still a form of fraud.

    It's sad the bankers either don't realize this or they just turn a blind eye to the practice. We haven't learned anything.

    That being said, I do agree that it is unfair many banks treat the self-employed and the employee differently concerning loans. However, as the old saying goes, “two wrongs don't make a right.”

    • How is it gaming the system? Our legal system allows for us to be LLCs with S-Corp for tax purposes. It requires an S Corp to issue salary to the owner. Now you could game the system by issuing incorrect W2 information but that is a Federal offense.

      What I suggested is in no way fraud. It is a perfectly legal use of the system as it is designed today. I can register a C corp as well for not much more money and a few extra forms a years. Does that mean that would be unacceptable as well?

      Using legal means to navigate the world is why the wealthy get and stay wealthy. The laws are there. Use them to your advantage in a legal and moral manner. I would never suggest that anyone do anything immoral, unethical or illegal just to get a mortgage or for any other reason.

  • They should not be surprised, much less devestated, that they are being declined for a mortgage. They will have NO INCOME – all they have is a business plan for a new business. It doesn't matter if they had a successful business before- for all intents and purposes they are closing it and moving to an entirely new area to start an entirely new business with all brand new clients.

    If it was a stand-alone business that could be run from anywhere, the bank would consider that historical income. But it's not like they own a manufacturing company which is being managed by a third party. After they move they will lose all their clients and will no longer receive any more income from that business. They are starting from scratch. Which happens to be very risky, especially in this economy.

    As a banker, there is no way we would give a mortgage to somebody who is about to quit their job and try to find another one – so why would we give one to people who are doing something even MORE risky. It generally takes over a year for businesses to become profitable. Giving mortgages to people doing what your relatives are trying to do is one thing that led to the mess we're in now.

    Sorry for the rant, but it's like bankers can't win no matter what.

    • My husband and I are both self-employed Canadians and things are much the same here….in deciding to become entrepreneurs we recognized that we were in essence opting out of many of the social safety nets: as self employed persons we are not eligible for unemployment insurance (incl. maternity leave), or worker's compensation and of course, have no pension plans or other corporate benefits. Dealing with the banks is equally difficult here as well….as I imagine it must be in most countries. Personally we were willing to accept all the risks inherent with self-employment; though I honestly believe that if we had to give up health insurance as well (as Americans do) we would have had to make other choices.

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  • MoneyEnergy

    That's pretty weird; what about “national” banks like Bank of America, wouldn't they recognize this couple's credit history, etc.? Amazing that there would be such barriers between states of the same country, especially for citizens. But I guess that's the point of keeping power down at the lowest levels, right? NC gets to make its own financial decisions too…. interesting to hear about.

  • Okay, in general Steve is right. There are a lot of instutional barriers in the US for self-employment. I've had self employment income for almost two decades, and have found it difficult for banks to recognize that, even as they accept my business checking accounts. And the IRS (Inland Revenue, for those of you in the UK) is predisposed to believe that you are hiding income; I've been audited most years since the early 1990s. In the US, self-employed also have to pay both the employee *and* employer share of Social Security.

    I wish it were different, but institutionally it's not nearly as bad as many countries in Europe, where self-employment is actually looked down upon by many of your peers. And despite the barriers, we still get a lot of people who choose this direction, and succeed to at least some extent. I think that if you are comfortable with the costs and risks involved, it has the potential to lead to a compelling lifestyle.

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  • How is it gaming the system? Our legal system allows for us to be LLCs with S-Corp for tax purposes. It requires an S Corp to issue salary to the owner. Now you could game the system by issuing incorrect W2 information but that is a Federal offense.

    What I suggested is in no way fraud. It is a perfectly legal use of the system as it is designed today. I can register a C corp as well for not much more money and a few extra forms a years. Does that mean that would be unacceptable as well?

    Using legal means to navigate the world is why the wealthy get and stay wealthy. The laws are there. Use them to your advantage in a legal and moral manner. I would never suggest that anyone do anything immoral, unethical or illegal just to get a mortgage or for any other reason.