If you are self-employed and cash-strapped, you may be eligible for credit options including personal loans. Personal loans provide a certain amount of money that you can repay over a certain period of time, and they are useful for borrowers looking to consolidate debt or pay large or emergency expenses.
Before you start looking for a loan, you should know what to expect as a self-employed applicant. It’s also important to consider all options to make sure a personal loan is the right one — it probably isn’t.
“If you’re self-employed and you’re a business, you shouldn’t be looking for a personal loan,” says Lori Atwood, a board-certified financial planner and founder of Atwood Financial Planning and Fearless Finance. “Make sure you have all the correct cash flow evidence if it works for you.”
Is it harder for self-employed people to get personal loans?
Every loan applicant is different, and it doesn’t have to be harder for the self-employed to get a loan, regardless of employment status.
“Whether you’re self-employed or employed, going through the underwriting process is always a balancing act,” said Brian Walsh, CFP and senior manager of financial planning at SoFi. For example, borrowers with higher incomes relative to debt payments may not need as strong a credit rating, Walsh said.
However, if you are new to self-employment, you will not be able to easily demonstrate that your income is stable. This can make borrowing more difficult.
“They may still be eligible because lenders take into account their credit history, education, free cash flow, and maybe their financial and payment history and so on,” Walsh said. “But when they only do it for a year, it becomes more difficult.”
If you’re new to the business, add a co-signer for credit. “The co-signer needs to be independently wealthy, and in the case of young adults, it can sometimes be a parent or grandparent that can do that, or if it’s a spouse or friend,” Atwood said. The person needs to have a W-2 work, they know there’s money coming in. ”
If you are self-employed, how can you prove your income?
While self-employed borrowers cannot provide the same documentation as other workers, they should still be able to provide satisfactory proof of income when applying for a personal loan.
“Any time a self-employed person goes through the credit process, they should expect to provide additional documentation that I would not provide as a W-2 employee,” Walsh said. “It could be a document of your income, such as tax returns from past years. It could even be a document such as financial statements or bank statements, showing that the inflow is indeed a continuous inflow.”
Likewise, if you’re new to being self-employed, getting a loan may be harder — you may not have tax returns that reflect income and expenses, or bank statements that show consistent cash flow. However, if you work in a similar industry, it may be easier to give your opinion.
For example, an experienced plumber who recently started a business as a plumber earns more than an experienced plumber who decides to run a restaurant, says Ryan Olson, vice president of consumer credit at Community First Credit Union in Florida. Income is more predictable. “We also look at previous jobs. Are they similar or similar industries, are they staying in similar industries to migrate to this new level of self-employment?”
Should you get a personal loan if you are self-employed?
A personal loan can be a useful tool for borrowers looking to consolidate high-interest debt. They’re also usually unsecured, meaning you don’t have to put down collateral to get financing like you would a car or house.
But Atwood says you should avoid taking on personal debt for business expenses. “The last thing you want to do is fund a business yourself.”
If you already have personal credit card debt to fund your business, it might make sense to get a personal loan at a lower interest rate. “But if someone comes to me with a business idea, they shouldn’t be looking for a personal loan or funding it themselves,” Atwood said.
Debt can also make it harder for self-employed individuals to manage their cash flow. “Probably the biggest challenge I see working with freelancers is managing cash flow,” says Walsh. “And often when they manage cash flow and control their debt as much as possible, it’s very critical.”
Before you take out a personal loan, make sure you really need the money. “You probably shouldn’t be borrowing money for this unless you absolutely need it,” Walsh said.
Remember, in order to get low interest rates on personal loans, you need a strong credit history. You can also consider different types of lenders, including online lenders and peer-to-peer lenders. Prequalifying with multiple lenders can help you find the best option.
If you are self-employed, what other ways are there to obtain financing?
Personal loans may be useful for some consumers, but they are not always the right choice. Depending on your financial situation and how you plan to use the loan funds, you may also consider the following options:
- Commercial loans. If you want to finance your business, you might consider a small business loan. Options include term loans and equipment loans.
- Equity financing. If the business you’re starting is years or may not have any cash flow at all, Atwood recommends considering selling an equity stake. In this case, you sell part of the business ownership.
- Home equity loan or cash out refinance. If you own a home and have assets, you can use any of these tools to get cash. With interest rates currently low, developing home equity is a particularly attractive option, Walsh said.
- A credit card with 0% APR. If you’re considering a personal loan to consolidate your credit card debt, you can also check out a 0% APR credit card, which typically charges no interest on balances between 12 and 21 months. You can transfer your existing balance to the card, but be sure to plan to pay off your debt before the introductory period ends. Otherwise, your debt will start earning interest again.
- Guaranteed personal loan. Personal loans are usually unsecured, but lenders also offer secured options. In this case, the borrower provides collateral such as a car or boat, which they risk losing if they don’t repay the loan. In return, borrowers receive lower interest rates. “The interest rate on your unsecured loan is higher than on a typical secured loan, which of course all depends on creditworthiness,” Olson said.
In general, when deciding on a personal loan, you should consider what you want to do with the money. “I can’t stress enough that people need to match their money with the cause they’re trying to fund,” Atwood said.
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