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Why It Is Harder To Get Loans When You Are Self Employed

Why It Is Harder To Get Loans When You Are Self Employed

Around 6.1% of employed Americans were self-employed in 2019, but the number of self-employed may increase more in certain occupations than in others. By 2026, the US Labor Statistics Bureau estimates that self-employment will increase by almost 8%.

In addition to increased flexibility, some self-employed people also have high salaries. Dentists, for example, are typically self-employed but earned an average annual wage of $ 159,200 in 2019. Conversely, real estate appraisers, another career in which self-employment is common, earned an average annual wage of $ 57,010 in 2019.

Despite high wages and job security in some industries, there is one area in which the self-employed can have problems – qualifying for loans. If you are working for yourself, you may need to jump through additional frameworks and have extensive work experience to get approval for a mortgage, take out a car loan, or qualify for any other line of credit you may need.

Why is it important for believers to be self-employed?

Here’s the good news: Being self-employed doesn’t directly affect your creditworthiness. However, some lenders may be suspicious of lending to self-employed applicants, especially if you have been self-employed for a short period of time.

When applying for a mortgage or other loan, lenders consider the following criteria:

  • Your income
  • Debt to income ratio
  • Credit score
  • financial assets
  • Employment status

Generally, lenders will confirm your income based on the pay slips and tax returns you have submitted. You can check your creditworthiness with the credit bureaus by putting a hard query on your credit report and confirm your debt to income ratio by comparing your income to the debt you currently owe. Lenders can also check what assets you have by getting copies of your bank statements or other evidence of assets.

The final factor – your employment status – can be more difficult for lenders to assess whether you are self-employed and manage multiple clients or jobs. Bringing in unpredictable streams of income from multiple sources is vastly different from earning a single paycheck from an employer who pays you a salary or a set hourly rate. If your income fluctuates or your self-employed income is seasonal, it can be considered less stable and slightly risky for lenders.

That said, being honest about your employment and other information when applying for a loan will work better for you overall. Most lenders ask about the status of your employment in your loan application. However, your self-employment status may already be listed with the credit bureaus. Either way, a surefire way is to be dishonest with a loan application to make sure you get rejected.

Additional steps to self-employed approval

If you apply for a mortgage and are self-employed, you usually need to provide information more proof a more reliable source of income than the average person. Lenders look for evidence of income stability, the location and nature of your job, the strength of your business, and the long-term viability of your business.

To demonstrate that your self-employed status will not affect your ability to repay your loan, you will need to provide the following additional information:

  • Two years personal tax return
  • Two years of business tax return
  • Documentation of your self-employment status, including a list of clients when prompted
  • Documentation of your business status, including business insurance or business license

Applying for another line of credit, like a credit card or a car loan, is considerably less intensive than applying for a mortgage – regardless of whether you are self-employed or not.

Most other types of credit require you to fill out a credit application that includes your personal information, your social security number, information about other debts you have such as a housing benefit, and information about your employment status. If your creditworthiness and income are high enough, you may be eligible for other types of loans without jumping through additional limits.

10 Ways The Self Employed Can Get Loans

If you work for yourself and want to make sure you qualify for the credit you need, there are numerous steps you can take to prepare yourself for success. Immediately take the following steps.

1. Know where your credit is

You can’t work on your bankroll if you don’t even know where you are. To start the process, be sure to check your credit history to see if it needs work. Fortunately, there are a few ways to check your FICO credit score online and for free.

2. Apply with a co-signer

If you don’t have enough credit or income to qualify for a credit rating, you can also apply for a loan from a co-signer. With a co-signer, you can count on the high credit and positive credit ratings to increase your chances of approval. However, if you choose this option, be aware that your co-signer is jointly responsible for repaying the loan in the event that you are in default.

3. Go straight to your local bank or credit union

If you have a longstanding relationship with a credit union or local bank, they already have a general understanding of how you handle money. When that trust is established, it may be ready to provide you with a line of credit if other lenders don’t.

This is especially true if you have had a deposit account with the institution for at least several years. In any case, it is always a good idea to check with your existing bank or credit union when applying for a mortgage, car loan, or other line of credit.

4. Decrease your debt to income ratio

The Debt to Income Ratio (DTI) is an important factor that lenders consider when applying for a mortgage or other type of loan. This factor is the amount of your debt compared to your income and is expressed as a percentage.

If you have gross income of $ 6,000 per month and, for example, fixed expenses of $ 3,000 per month, your DTI rate is 50%.

Too high a DTI rate can make it difficult to qualify for a mortgage or other line of credit if you are self-employed. For mortgage qualifications, most lenders prefer to borrow money to consumers with a DTI rate of 43% or less.

5. Check your credit report for errors

Check your credit reports regularly to keep your credit in the best shape possible. You can get your credit reports free of charge every 12 months at AnnualCreditReport.com from any of the three credit reporting agencies.

If you find mistakes in your credit report, take steps to address them immediately. Correcting mistakes in your report can give your score the real boost it needs.

6. Wait until you have built an independent income

As a self-employed person, it typically takes two years of tax returns to qualify for a mortgage, and you may not be able to qualify until you hit that threshold. With other types of loans, it can definitely be helpful to wait at least six months to become self-employed before applying.

7. Separate business and private funds

Keeping personal and business funds separate when filing your taxes is helpful, but it can also help you reduce your liability for certain debts.

For example, let’s say you have a large amount of personal debt. If your business is structured as a corporation or LLC and you are in need of a business loan, separating your business funds from your personal funds can make your loan application look cheaper to lenders.

As a separate issue, start building your business credit score early on, separate from your personal credit score. By setting up commercial bank accounts and signing up for a business credit card, you can manage both buckets of your money separately.

8. Expand your savings fund

Having more cash is a good sign from a lender’s perspective. So try to build your savings account and investments. For example, you can open a high-yield savings account and save three to six months on spending as an emergency fund.

You can also open a brokerage account and invest regularly. Both strategies will help you build your wealth. This shows that despite having an irregular income, lenders have a better chance of repaying your loan.

9. Provide a larger deposit

Some lenders have tightened mortgage qualification requirements, and others even require a 20% down payment for home loans. You also have a better chance of getting a car loan with the best rates and terms with more money, especially for new cars that are rapidly depreciating.

Aim for 20% off a home or car that you buy. As a bonus, paying a 20% deposit on your home purchase will help you avoid paying for private mortgage insurance.

10. Get a secured loan or a secured credit card

If your credit profile is thin or you have made mistakes in the past, don’t forget what steps you can take now to build credit. One way to do this is to apply for a secured credit card or loan. Both require collateral in order to get started.

The whole point of having a secured credit card or secured loan is to improve your credit score and prove your self-employed credit when you cannot be approved for unsecured credit. After you have made enough on-time payments for the secured card or loan, your credit score will increase. You can upgrade to an unsecured alternative and get your deposit or security back.

The bottom line

If you are self-employed and fear that your job status is affecting your chances of getting a credit score, then you shouldn’t. Instead, focus your time and energy on creating a steady stream of self-employed income and improving your credit score.

Once your company is established and you have been self-employed for several years, your work status no longer matters. Keep your income high, your DTI low, and a positive credit balance. You have a better chance of getting loan approval.


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