Applying For A Personal Loan While Self-Employed
So your FICO® Score is high. You have plenty of savings in the bank. Your debt is low. Let's be honest, you'd be the perfect candidate for a personal loan except for one thing: you're self-employed.
Applying for a loan is always stressful. But qualifying for a personal loan when you're self-employed is even more of a challenge.
Why can it cause added trouble? Self-employed borrowers often claim so much of their revenue as business expenses that it leaves them with a final yearly income that looks too small to many lenders. And then there's the unfortunate problem of consistency. Lenders worry that borrowers who can't rely on a steady salary from a full-time job are more susceptible to income swings that will make it difficult for them to make their loan payments each month.
Learn what's different for self-employed workers when acquiring a personal loan.
Can I Get A Personal Loan If I'm Self-Employed?
Self-employment doesn't mean qualifying for a personal loan or mortgage is impossible. You can normally find a loan that works for your situation even if you don't rely on a steady, full-time salary. You'll just need to provide plenty of additional documents to prove that your income is steady. And you might need to find a lender that relies on more than your tax returns when deciding whether your income is high enough for a loan.
Self-Employed Loan Requirements
There’s no need to feel discouraged if you’re wondering how to get a personal loan while relying solely on a self-employment income. You might just need to gather more information than those who aren’t self-employed.
First, it’s important that you can show sufficient, stable income from self-employment. It’s ok if you have some slight fluctuations in your income now and then, but lenders ultimately look for an ongoing, upward trend. Of course, lenders also want to see that an applicant has good credit and a history of repaying debts. Lenders will look at the type, age, limits, use and status of existing accounts and also see how often an applicant has applied for new credit within the past year.
Next, lenders want to see that a loan applicant has steady work and has been self-employed in the same industry for at least two years. It can be possible for an applicant with one year of experience to be approved for a loan if they present additional information, however, having a shorter history of employment indicates risk to lenders.
Lenders may also look to see if an applicant has cash reserves, or an emergency fund that can be used to pay bills during months when income might be lower.
If you can demonstrate each of these factors and have a strong financial profile you will be more likely to qualify for a personal loan.
Ways To Prove Income When Self Employed
Proof of income is a very important part of the loan approval process. If you’re self-employed, here are ways you can show proof of income:
- Pay Stubs. Pay stubs include an applicant’s full name, employer’s name and contact information and are used to show lenders a past and current profile of an applicant’s income.
- Tax Statements. Your tax statement from the previous year (1099) contains your wages and taxes. Because tax statements are legal documents, many lenders see them as the most reliable proof of income for self-employed individuals.
- Bank Statements. If an applicant has a history of regular deposits, bank statements can show a stable flow of income. Just make sure to keep your business expenses separate from your personal ones.
- Profit & Loss Statements. A profit and loss statement (or ledger documentation) is a summary of your costs, expenses and revenues. This can show a lender more about your income.
- Social Security Benefits Statements. A Social Security benefits statement shows an applicant the benefits they will receive when they retire. You can access your statement through the Social Security Administration.
- Court-Ordered Agreement. Examples of court-ordered agreements can include alimony or child support. You can request a copy of these agreements from the court.
The Income Challenge
Benie Khan, a lender with San Diego's FedHome Loan Centers, says self-employed borrowers always face the same hurdle when applying for a personal loan: they claim too much of their earnings as business expenses on their income taxes.
This helps when it's time to pay taxes. By claiming more expenses, self-employed borrowers reduce their taxable income. But lenders must base their lending decisions on the final income that borrowers report on their taxes. And often, this income is so low that borrowers struggle to qualify for a personal loan or mortgage.
Here's an example: Say your business earns $100,000 in revenue in a given year. When it's time to pay your taxes, you claim $50,000 worth of business expenses. This reduces your taxable income, the income you report to the IRS, to $50,000, leaving you with a far smaller tax bill.
But when you apply for a personal loan, lenders won't make their decision to approve you based on the $100,000 your business earned. Instead, they'll look at your final income figure of $50,000. This can then make it difficult to earn approval for a larger loan amount.
"The biggest hurdle is showing that there is sustainable income," Khan says. "Most self-employed borrowers don't have any income after all the business write-offs have been deducted from their taxes."
Morgan Taylor, finance expert and chief marketing officer for Scottsdale, Arizona-based LetMeBank, says self-employed borrowers will need to prove that their income is consistent from year to year. Lenders don't want to see that in one year you've earned $40,000 and the next $120,000. Why? They worry that while you'll be able to make your payments during the up years, you won't during any down years your business might experience.
"In the end, lenders want to know you're able to pay on the loan," Taylor says. "This means that regardless of what you're doing, lenders want to know that it is long-term and consistent. It's great if you get $10,000 this month. But if that drops down to nothing for the next 5 months, that's not very reliable, is it?"
If you can provide lenders with several years’ worth of tax returns all showing that your self-employment income is steady, the better your odds of qualifying for a personal loan.
A longer history of tax returns will help prove to lenders that your self-employment income is steady and reliable. You might also have to show more copies of your bank account statements. Most borrowers have to show two months of these statements. Self-employed borrowers might have to show more to convince lenders that they always have enough in their bank accounts to afford their payments.
Taylor says the longer you've been self-employed, the better. Lenders will be more comfortable with borrowers who have relied on self-employment income for several years than they are with those who have just made the leap to working for themselves.
It helps, too, if you have a strong credit score, low debt-to-income ratio, and plenty of cash in reserve. All of this will help offset the worries lenders have about your self-employment income.
Personal Loan Alternatives When Self-Employed
If you are unable to receive a personal loan, a credit card might be your next best option. Having a credit card can help you build or improve your credit history if you make your payments on time. Then, the next time you apply for a personal loan, you will have a better chance of qualifying for it.
Having a credit card will allow you to take out a short-term loan, or cash advance. Cash advances are useful for situations where you need cash in hand and can’t just swipe your card. But be on the lookout because the APR for a cash advance can be higher than the APR for regular purchases.
Home Equity Loans Or Home Equity Lines Of Credit
If you own a home, you might be able to borrow from the equity in your home through a home equity loan or a home equity line of credit. A home equity loan has a fixed term and gives borrowers the money in one lump sum. On the other hand, a home equity line of credit lets borrowers make payments only on the amount borrowed.
A business loan is strictly intended for business purposes and can be used by self-employed individuals. Business loans are useful for individuals who are self-employed because it can help them separate business and personal expenses. With that being said, business loans are not flexible and can only be used for business purposes.
The point here? Even if you are self-employed, you can still qualify for a personal loan. The key is to show lenders that your income stream is steady each year. This will give lenders confidence that you’ll be able to make your payments on time each month.
And as you shop around with different lenders, apply for personal loan with us.
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