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 or a mortgage loan except for one thing: you're self-employed.
Applying for a loan is always stressful. But qualifying for a personal loan or mortgage 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.
Regardless, self-employment doesn't mean "unqualified." 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.
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 or mortgage: 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 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 mortgage, say, of $300,000.
"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."
This is why many lenders offer what are known as bank-statement loans. With these loans, lenders look at borrowers' bank accounts instead of their tax returns. This is a help to self-employed borrowers. These borrowers' tax returns might show a lower yearly income because of all the business expenses they write off. But these same borrowers' bank accounts might show plenty of cash, making these borrowers more attractive to lenders.
When looking for a loan when you are self-employed, ask lenders if they offer bank-statement loans. You might find that smaller banks or credit unions are more willing to consider alternative methods of verifying that you have enough money to cover your loan payments.
Bank-statement loans usually allow self-employed borrowers to use their last 12 months of bank statements to verify their income. Be aware, though, that lenders won't consider all the money in your bank account as income. They will only treat 50% of the deposits during your 12 months of statements as income. This helps account for the money that self-employed people spend on running their businesses, money that borrowers won't have immediately available to them for personal loan or mortgage payments.
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 mortgage or 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.
Apply with Different Lenders
If you're self-employed, it might make sense to also shop around with several lenders. One lender might hesitate to work with you, but the next might be happy to offer you a loan.
Why? Melissa Cohn, executive vice president of Family First Funding in New York City, says many lenders today offer specialized programs for self-employed borrowers. Borrowers just have to find the lenders that offer these.
"Many self-employed borrowers make enough money to qualify, but with the write-offs that they can take on their tax returns, their adjusted gross income may not show enough income," Cohn says. "Luckily, there are more options available for self-employed borrowers."
Cohn pointed to bank-statement loans. But she also says some banks offer programs in which borrowers produce profit-and-loss statements for the current year. The bank then uses the income on this statement instead of the reported income on tax returns. Some banks also rely upon a simple letter from a certified public accountant stating gross income.
The point here? Even if you are self-employed, you can still qualify for a personal loan or mortgage. 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.
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