Self-employment is a rewarding approach to earning a living. However, while self-employment offers more professional control and flexibility, you may also encounter unique challenges.
For example, applying for a personal loan can be tricky if you’re self-employed, especially if your earnings are irregular or difficult to prove. Most self-employed workers are small business owners who don’t receive pay stubs or W-2 tax forms, standard requirements for a personal loan.
However, by filing additional documentation to demonstrate your income, you can secure a personal loan while self-employed.
What is a Personal Loan?
To give yourself the best chance of being approved for a loan at a reasonable rate, it’s essential to understand the process and proof of income that lenders require.
A personal loan is an agreed-upon sum of money you can borrow from a bank, credit union, online lender, or other financial institution that you must repay with interest over time. The length of the repayment term can vary, but it is typically between one and five years.
You can take out a personal loan for various reasons, whether you need to cover a medical bill, plan a wedding, or take on a home renovation project. Personal loans can also be used for debt consolidation, combining multiple debts into one manageable repayment. Most personal loans are unsecured, which is different from other loan types, like car loans, business loans, or mortgages.
Unsecured loans don’t use collateral as security. Instead, you must demonstrate creditworthiness through other means, like a good credit score and proof of income.
Personal Loan Tips for the Self Employed
If you don’t have a regular payment history, years of pay stubs, and an official letter of employment, there are other ways to prove your creditworthiness. Lenders want to know that you have consistent year-to-year earnings before determining if you qualify for a personal loan.
Consider the following tips to boost your chances of getting loan approval with reasonable rates and terms.
Prepare documents to prove earnings
To demonstrate a history of consistent earnings, lenders typically need proof that you have been self-employed in the same industry for at least two years. They will also look at how often you’ve applied for credit within the past year and check to see if you have an emergency fund for making monthly payments during your slow season.
Self-employed individuals must demonstrate their ability to repay a personal loan using documents such as profit and loss statements, court-ordered agreements, bank account statements, tax records, and social security statements.
Improve your credit score
Your credit score is one of the most important factors when applying for a loan. It is represented by a number, usually between 300 and 850, and helps lenders predict your ability and likelihood of repaying your loan on time. FICO scores are one of the most widely used scoring systems in the United States. It uses five weighted criteria to establish your score:
- Payment history (35%)
- Accounts due (30%)
- Length of credit history (15%)
- Credit mix (10%)
- New lines of credit (10%)
According to myFICO, a score of 670 to 739 is regarded as good, 740 to 799 is very good, and 800+ is exceptional. Work on improving your credit score to boost your creditworthiness. Effective ways to improve your score as a self-employed professional include:
- Paying off past due debts
- Making payments on time
- Lowering your credit utilization ratio (ideally below 30%)
- Avoiding opening hard inquiries on your accounts within a year of applying for a loan
Explore options from multiple vendors
Lenders and financial institutions don’t necessarily share the same requirements for personal loans. Some are more lenient in terms of acceptable credit scores, while others adhere to strict criteria for approval. Self-employed borrowers’ can seek personal loans from banks, credit unions, and online lenders.
- Banks: Banks offer competitive interest rates and higher borrowing limits. However, their interest rates and penalty fees can be higher than other lending institutions. To apply for a personal loan from a bank, you’ll need a bank statement, 1099s, and income tax returns.
- Credit unions: Credit unions are excellent lending resources, frequently offering competitive rates and favorable terms. They are member-owned, not-for-profit organizations, so they tend to be more willing to work with customers with average credit scores. The application process tends to be less rigid than a bank; however, you need to be a credit union member to apply.
- Online lenders: Many online lenders are recently established, so it’s crucial to do a background check on the provider. Online lenders typically grant loans to applicants with lower credit scores in low-income brackets. However, they are often more suitable for smaller loan amounts like Payday Loan or Microloan. These loans have higher interest rates and a short repayment term.
Consider a secured loan
If you’re struggling to qualify for an unsecured personal loan, consider putting up collateral and applying for a secured loan. Secured loans lower the financial risk undertaken by the lender, making it easier to get approval.
You can include cash from a savings account, a vehicle, or even a property as collateral. However, the lender can use your money or property to recover their losses if you default on the loan.
Apply with a co-signer
If you have a low credit score or cannot produce the necessary documents for a personal loan, a co-signer can help you meet the minimum requirements. A co-signer agrees to share the responsibility for repaying the loan, reducing the risk for the lender. However, if you fail to make payments, the co-signer assumes responsibility.
Prepare Your Loan Application With Resources From Finance is us
If you need to borrow money for a personal expense as a self-employed professional, there are alternative means to secure funding. A home equity loan or new credit card may be viable options, particularly if you’re just getting your business off the ground. However, learning about the loan process and requirements can boost your chances of personal loan approval.
At Finance is us, our team is dedicated to providing detailed information about loans, banking, investments, and other financial topics. Whether you’re self-employed or a first-time homebuyer, explore our informational blog for more information on how to boost your financial health.
Disclaimer: All content on this site is information of a general nature and does not address the circumstances of any particular entity or individual, nor is the information a substitute for professional financial advice and services.