Entrepreneurs often dream of designing their best lives through self-employment. Having flexibility over their schedules, free reign over projects, and working in an industry they love are just a few of the attractive benefits. However, without a traditional career, individuals looking to qualify for personal loans, credit cards, or even a home equity line of credit might struggle to meet general requirements.
Being self-employed shouldn't — and doesn't have to — limit an individual’s ability to finance. It might be more difficult to qualify compared to traditionally employed borrowers, but loans for the self-employed professional are not unachievable.
Challenges for self-employed borrowers
Are loans for self-employed individuals viable? Yes — obtaining a loan is possible. Unfortunately, a few roadblocks have the potential to hurt your chances. Understanding and mitigating these obstacles before applying for a loan can help better the chances of qualifying.
- Lack of traditional proof of income: Unlike salaried employees who can provide pay stubs or W-2 forms, income as a self-employed professional can vary monthly. Since traditional lenders often rely on stable income documentation, it can take some work to showcase your financial stability.
- Income fluctuation: Lenders often consider proof of income and overall financial health as determining factors in a lending decision. Lacking consistent income can raise concerns. If your income varies significantly or experiences seasonal fluctuations, it may impact a lender's willingness to work with you.
- Extra lending requirements: Lending terms and requirements can also differ for self-employed individuals. Financial institutions may require additional documentation to qualify for a personal loan application — such as years worth of tax returns, bank statements, and profit/loss statements. Meeting these requirements can sometimes be more time-consuming and complex compared to the straightforward employment verification process for traditional employees.
Tips to better your chances of obtaining a loan
Securing a loan with no income or as a self-employed individual may require some extra effort. Still, with the right strategies, you can significantly improve your chances of qualifying for the financing you need.
Maintain detailed and organized financial records
Organized records can help you manage your business effectively — and provide valuable documentation to showcase your financial stability to lenders when it’s time.
Be prepared to provide the following documentation to a future lender:
- profit and loss statements
- bank account activity
- any other documentation that provides proof of income
You can use accounting software to track earnings, expenses, and general cash flow. If you’re earning enough, set up a payroll system that establishes a regular pay schedule and earnings per month. Keep track of 1099-K forms issued by financial platforms such as PayPal, Zelle, CashApp, and any 1099 forms issued by companies you work with.
Prepare your tax returns
Tax returns play a crucial role in verifying your income as a self-employed individual. The records help you showcase your income beyond seasonality, highlight your longevity as an entrepreneur, and shed light on your financial health. Tax returns should be current and accurately reflect your business revenue and expenses. You'll certainly need to provide lenders with copies of your recent tax filings and past years.
Boost your credit score
A strong credit score and credit history can be helpful since lenders use credit scores to gauge an individual's borrowing credibility. Make it a priority to maintain good credit habits by paying your bills on time, keeping your credit utilization low, and avoiding excessive debt.
If your credit score is low, try the following tips to increase your credit score:
- Add utilities and rent to your credit report
- Limit your credit applications
- Become an authorized user
- Use your yearly free credit report to review and dispute any errors
Increase your collateral
A secured loan may be a more accessible option for a self-employed individual than an unsecured one. Collateral helps to reduce the perceived risk the lender is taking on by working with you. A simple way to accomplish this is to use a secured product — such as a home equity-based product.
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Alternative options for self-employed individuals
Traditional lenders might not always be a good fit for your lending needs. Happily, there are different types of financing options available to you. Some options may be more attractive than others.
Crowdfunding is a newer funding resource for entrepreneurs who are comfortable managing all of the different moving parts associated with a successful crowdfunding campaign. For example, suppose you’re comfortable doing active outreach and delivering additional products or goods promised to different funding tiers. In that case, crowdfunding may be an exciting way to raise funds for your business.
The Small Business Association (SBA) provides wide-ranging support for small business owners — such as mentorships, information on business best practices, and financial resources. Compared to other options, a small business loan can take considerable time.
Business grants are a great option if you don’t need immediate financial relief. Grants are unique in that recipients typically don’t have to repay them. You can apply for grants through local organizations, private and public foundations, and programs connected to local and federal government agencies.
Home equity products
Homeowners often have pent-up wealth sitting in their homes — in the form of equity. Equity is the difference between the home's current market value and the remaining balance on the mortgage. If your home has increased in value, consider using the equity to pay for business expenses, fund home improvements, or pay down debt. Since these products allow you to borrow against the equity you have in your home, they're secure and can have more flexible requirements to qualify.
Home equity loan
With a home equity loan, lenders evaluate the value of your property and the amount of equity you own to determine if you qualify and how much you can borrow. You receive the loan amount upfront and can use it for whatever you need. Repayment typically involves making fixed monthly payments over a specified period, usually 5 to 30 years. The interest rates are often lower than other types of unsecured loans.
A cash-out refinance involves financing your existing mortgage for an amount higher than what's owed so that you cash in on the difference. Like other products, lenders evaluate property value, creditworthiness, and other factors to determine eligibility and the loan amount. Once approved, the original mortgage is paid off, and the homeowner receives the remaining funds in cash. Repayment terms for the new mortgage are monthly payments based on the loan amount, interest rate, and chosen loan term.
Home Equity Investment
A Home Equity Investment (HEI) is not a loan but a product that allows you to access a lump sum of cash in exchange for a share of your home's future appreciation. Unlike other home equity products, there are no monthly payments. Instead, homeowners can buy back their equity anytime within a 30-year term when they decide to sell or refinance.
HEIs are also more flexible compared to other products. There are no income requirements or need for perfect credit.
While specific loans may not be tailored exclusively for self-employed professionals, several options can cater to your needs. Whether you're looking to invest more in your entrepreneurial venture or need cash to tackle debt or home repairs, having a non-traditional career shouldn't stop you from getting finance.
To find out more about what a Home Equity Investment (HEI) can do for you or to discuss your eligibility, consider reaching out to a Point specialist.