With the number of self-employed and freelance workers in the United States sitting at right around 57 million people, it’s not surprising that this growing section of the population needs financial advice. After all, you’re stuck with problems like figuring out complicated tax issues, getting a small business credit card, finding your own health insurance, and dealing with the conundrum of proving you’re financially stable without a traditional paycheck.
If you find yourself short on working capital or in need of some extra cash, you’ll want to understand the basics of loans for self-employed individuals. Don’t wait until you’re desperate for money. Instead, read more now so you’re already prepared when the time comes.
The Challenge of Proving Income
Before a lender is willing to give out a loan, they need to be sure that the borrower is capable of paying them back. Traditionally, they’ll require proof of income in the form of paystubs and W2 tax statements.
When you’re self-employed, however, you’re not likely to have these documents. So what can you do?
You may need to be a bit more selective about which lender you work with. Many lenders realize that self-employment is growing in popularity, so they’ve adjusted their requirements to account for this. The documents they may accept instead include:
- Bank statements
- Tax returns
- Financial statements
- Business documents
- Lease agreements
You’re also more likely to get approved if you have good personal credit, keep excellent records, and have solid business projections. Maintaining a decent amount of liquidity is another advantage, although if you have a ton of cash on hand, you might not need to apply for a loan in the first place.
If you’ve just started working for yourself or your income fluctuates drastically from year to year, you might have difficulty getting approved.
Other Lender Considerations
In addition to the challenge of proving your income, there are also several other issues that can make loan approval more difficult.
When you’re self-employed, the lender might also evaluate the long-term viability and sustainability of your business before approving your loan. They want to confirm that you not only have sufficient income now but that it’s likely to stay that way for at least the entire term of your loan.
This means they might consider the overall demand for the business or service that you offer, your business location, and its current and projected financial strength.
When you’re self-employed, you might also have difficulty documenting your various income sources. If you receive payment through PayPal, by check, or even in cash, you’ll need to have a way to keep it all organized. Hold onto all of your receipts and consider using a bookkeeping program like Quickbooks so you can easily create professional reports.
Self-employed business owners often take as many tax deductions as they can in an effort to improve their bottom-line. Unfortunately, this can create a negative impact on your ability to borrow. Since lenders will look at how much you make (on paper) after expenses, writing off a significant portion of your income can greatly reduce the amount of loan you’ll qualify for.
The amount of income you have documented will also impact your debt-to-income ratio. This is an important factor that goes into the lending decision.
A debt-to-income ratio is the amount of your total monthly tax payments divided by your monthly income. For example, if you have $2,000 per month in debt payments and your income is $4,000 per month, your ratio would be 50 percent.
Generally, lenders want this number to be at 43 percent or lower. Otherwise, they’ll have concerns that your loan payments are likely to become unmanageable, making it unlikely that they’ll approve your loan request. However, this is for traditional loans, and it is more likely that you could get approved when applying for personal loans with no credit check, but in many cases, this is either unnecessary or it may not help at all.
Higher Interest Rates
If you’ve met all of the other requirements, being self-employed doesn’t always mean that you’ll get stuck with a higher interest rate. However, it does increase the chances that you won’t qualify with a traditional lender. If you have to go to another source, there’s also a good chance you’ll pay a higher rate.
Your best bet is to get everything in order as much as you can, then do your research and shop around for the best rate and loan terms before committing.
If you’re having trouble getting a traditional loan, you may need to get a cosigner or put up collateral before you can get your hands on the cash you need.
What is a Cosigner?
A cosigner is someone who applies for a loan with you. This person is essentially vouching for you, agreeing to pay off the loan if you fail to make your payments. Having a cosigner makes you far more likely to get approved and may give you more options when choosing a lender.
Family and friends are often your best bet, although they’ll need to have a steady income and a good credit score to be able to help you out. If you ask someone to cosign for you, realize that it’s a big request and they may not feel comfortable doing it. If you’re lucky enough to get someone to agree, take your commitment seriously and make sure you don’t miss any of your loan repayments.
Putting Up Collateral
If you can’t get a cosigner, another option is to apply for a secured loan. This is a loan that’s backed by your financial assets, like your home or your car. This way, if you don’t pay back your loan, they can take the asset you’ve put up and sell it to cover the remaining amount of what you owe.
Mortgages, home equity lines, vehicle loans, and secured credit cards are all examples of collateral-backed loans.
Learn More About Loans for Self Employed Individuals
If you’re working for yourself, there’s a good chance that you’ll need to get financing for something. Now that you understand how loans for self-employed individuals work, you can prepare yourself in advance.
Need cash right now? Check out our list of the best personal loans available online today.
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