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How Do I Get a Loan if I'm Self-Employed?

| Money Rates Columnist
min read

self-employed-pizza-shopIt can be harder to find loans if you're self-employed. But lenders will approve installment loans for self-employed applicants if:

  • Their credit meets minimum guidelines
  • Income is consistent and reliable
  • The business and industry is healthy

Self-employed borrowers often have to supply more documentation than wage-earners to prove these things. This article illustrates what you'll probably need to apply for a personal loan when self-employed.

See interest rates for self-employed loans

Personal Loan Income for Self-Employed

Self-employment and personal loans should go together as naturally as burgers and fries. It seems so very logical. Self-employed individuals often have a need for cash, especially when they're just starting up. And lenders, of course, are in the business of lending.

But the reality is that if you're self-employed getting a personal loan is likely to be a different experience when compared with someone who holds a full-time job. Not harder, but different.

Lenders are certainly delighted to approve loans from the self-employed. The reason is fairly simple: the self-employed represent a large portion of the overall population. According to a 2016 report by the McKinsey Global Institute, "there are 54 million to 68 million independent earners in the United States."

Although lenders want to do business with the self-employed the application process is a little bit different. What lenders are looking for is not only good credit, a reasonable debt-to-income (DTI) ratio, and the other usual requirements but something more. What is the "more" that lenders really want? It has to do with verification, evidence that the numbers and information presented by the self-employed are accurate.

Applying for Loans When Self-Employed: What's the Difference?

Lenders like to see tax returns because they are very familiar with such forms and they know what the numbers mean. For a wage-earning loan applicant, the process is pretty simple. The individual's income is shown just as it appears on W-2 forms and other documentation. The lender can look at such documentation with great confidence.

With a self-employed borrower, the situation is different. The numbers which appear on tax returns are "net" figures, the amount an individual is required to report after deductions for expenses. The deductions themselves can include whatever the tax rules allow. Some items can be written off as current expenses while others can be depreciated over time. In many cases an individual must prorate an expense, dividing it into business and non-business costs.

The complications arise because many times a deduction for tax purposes doesn't have much to do with how much money is available for paying a mortgage. If you have a home office, for instance, you get to deduct a portion of the cost of running your home - utilities, property taxes, mortgage interest, maintenance, housekeeping, etc. - from your taxable income. Even though you'd probably have those costs whether or not you happen to use some of your space for working.

Self-Employed Borrower: It's About Taxable Income

You'll sometimes hear self-employed borrowers say they don't want lenders to see their tax returns for reasons of privacy and complexity. However, the other side of the coin is that lenders work with tax returns every day. They know how to look at the numbers. For instance, the self-employed may be able to take depreciation, a write-off that is not actually a cash expense. What do lenders do when they see a deduction for depreciation? For purposes of a loan application, they add it back to the borrower's income because it's not an out-of-pocket cost.

The big disconnect is that self-employed borrowers often see their "income" as the gross taken in by their business. But lenders must look at the bottom line as shown on a tax return. The result is that a self-employed borrower might feel he or she qualifies for a larger loan than the paperwork will permit.

Self-Employment Experience

The other item that can trip up a self-employed borrower is proving that the income is stable and continuous. Most lenders want to see a track record - a history of making money in your business. That usually means at least two years of self-employment in your field.

You can get around this requirement if you previously worked in the same field as an employee and are showing earnings comparable to what you earned as an employee. If you were a staff accountant and are now freelancing as an accounting consultant, your business has not really changed. But if you open up a restaurant, expect a harder road until you prove you can succeed in your new field.

What Forms Will I Need for a Self-Employed Loan Application?

A self-employed borrower does not receive payroll stubs or a W-2 year-end. However, the self-employed have other documentation they can use to verify their income.

  • Two years of business and personal tax returns
  • Year-to-date profit and loss statement
  • A balance sheet
  • A letter from CPA

Given new and emerging technology a self-employed borrower may actually need very little paperwork. The reason is that lenders can now get information directly from a variety of sources with borrower approval. For example, the lender can get a tax transcript from the IRS. Lenders can get bank account information directly from banks. In fact, many lenders would much prefer to get their account information directly from a bank since it's quicker and complete.

What Credit Score Do Self-Employed Borrowers Need?

Lenders expect borrowers to demonstrate a certain level of creditworthiness. Usually this is done by looking at credit scores and reviewing credit reports. Good credit is required to borrow money. Whether an individual has good credit because they hold a job or they're self-employed is really less important than the need for good credit, sufficient income, and a reasonable debt-to-income ratio.

As is always the case with lenders and lending, higher credit scores mean lower rates and often an easier time getting through the application process. Score requirements vary by lender. Some might be willing to provide financing with a 620 credit score while others require far higher scores. Because lenders have different standards it pays to shop around.

How to Apply for a Personal Loan

As a self-employed borrower in search of a personal loan you want to be sure that you select the right financial product. You really want a "personal loan" and not a business loan, a form of financing with fewer consumer protections.

The process for applying for personal loans is pretty much the same as the process for any form of financing. You'll do best if you have good credit, a low debt-to-income ratio, and needed paperwork in hand. In particular, as a self-employed individual, it can be advantageous to give lenders to access your bank accounts directly. Both the Experian Boost and UltraFICO programs use direct bank account access to better understand spending patterns - and to raise credit scores where possible.

Where Do I Find Personal Loans for Self-Employed People?

Given that there are tens of millions of self-employed entrepreneurs it follows that personal loans are available to them just about everywhere. Lenders want the business and entrepreneurs want the capital so there's a natural common ground between the two.

The big question a little bit different. How can self-employed individuals get the best possible personal loans? The answer is to shop around, keep your credit strong, and have nice thick files that lenders can use to verify your information.

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