Loans can fill a crucial gap for those who need to make a big purchase, survive a period of financial uncertainty, or take the next step in their career.
For self-employed workers, however, qualifying for a loan may be more complex. Whether you’re a freelancer, independent contractor, or business owner, lenders often need additional documentation to prove that your income and assets are risk-free.
This article will walk you through the potential challenges of obtaining loans while self-employed, best loan options, and tips for choosing the best funding source.
What Does “Self Employed” Mean?
Self-employed workers work for themselves independently to provide goods and services to customers and clients. The IRS defines self-employed individuals as those who carry on a trade or business as a sole proprietor, independent contractor, member of a partnership, or are in business for themselves part-time[1].
Most self-employed workers fall into two main categories:
Freelancers or Independent Contractors. Self-employed workers who work for themselves and are their own business. They typically take on multiple projects or commissions for multiple organizations at once and are paid on an hourly, per-task, or project basis.
Small Business Owners. Self-employed workers who own a business entity such as a sole proprietorship, limited liability corporation (LLC) or partnership, or corporation. Small business owners often employ other workers or self-employed workers.
Some self-employed workers fall under both categories. For example, many freelancers may be sole proprietors, or operate as LLCs. Many states treat categories of self-employed workers differently, so your employment status may vary depending on where and how you do business, your licensing, and individual state requirements for businesses[2]
Why Loans for the Self Employed Can Be a Challenge
Lenders look for lower-risk applicants with consistent sources of income who are most likely to repay loans on time. These requirements can present a challenge for self-employed workers.
Proof of Income
Self-employed workers often have to provide extra paperwork and documentation than traditionally employed workers to prove their income. Instead of submitting a single W-2 form or tax return as proof of income, self-employed workers may need to include the following during the application process:
- Tax statements: 1099s for freelancers and independent contractors, 1120s for S-Corporations, and 1065s for partnerships
- 2-3 years or more of tax returns
- Bank account statements
- Personal financial information such as social security benefits statements or court-ordered agreements
- Additional financial statements such as profit and loss statements
Income Inconsistency
Many self-employed workers have irregular income that ebbs and flows throughout the year. This is especially common for freelancers and independent contractors who have multiple clients and projects with different payment schedules. While small businesses like LLCs, S-Corps, and C-Corps have the option to pay themselves a consistent salary, sole proprietors, freelancers, and independent contractors do not.
Self-employed loan applicants may need to prove consistent income over time as well as a history of making payments on time.
Lower Taxable Income
Self-employed workers are responsible for paying income tax, Medicare, social security, and self-employment tax, but can deduct most business expenses. While these deductions do help decrease their tax burden, a lower reported taxable income can work against self-employed workers when it comes to loan applications because eligibility for loans is based on net income rather than gross.
Best Loan Options for the Self Employed
For self-employed workers, the most common loan choices fall into two categories: personal loans and business loans. Because these loans vary widely by term, size, and requirements depending on the financial institution you’re working with, we’ve provided a general overview of each loan type.
Personal Loans
Personal loans are a common option for people looking for quick access to cash for emergency expenses, home renovations, and other personal projects. Personal loans can also be used to cover small-business expenses, but are generally much smaller than small business loans, usually starting at $1,000 with a limit of $100,000 for most lenders.
If you need an infusion of capital to help meet living expenses as well as business startup or operating costs, a personal loan could be the right fit for you.
When applying for a personal loan, lenders will most likely consider the following factors:
- Credit score
- Annual income or revenue
- Payment history
- Debt-to-income (DTI) ratio[3]
A personal loan may work best if you’re a freelancer or independent contractor looking for a smaller loan you can use for mixed personal and business purposes. However, if you’re a small business owner with separate finances, taking on a personal loan is not recommended. Leveraging personal debt to pay business expenses can leave you financially liable for payments, affect your personal credit, and risk creating a more complex tax situation by mixing personal and business finances.
However, if you’re a small business owner with separate finances, taking on a personal loan is not recommended. Leveraging personal debt to pay business expenses can leave you financially liable for payments, affect your personal credit, and risk creating a more complex tax situation by mixing personal and business finances.
Small Business Loans
These one-time loans are designed for business expenses only and typically cannot be used for personal expenses. While there are many categories of business loans, they’re most often used for large purchases and long-term working capital or investments. Most institutions offer small business loans for specific purposes, such as equipment financing or property, and in a wide range of sizes, sometimes up to $3 million or more.
Types of Small Business Loans
There are three main types of small business loans, including:
- Secured Loans: Loans requiring applicants to put up personal or business assets as collateral in case of non-repayment. Because they are backed by assets, these loans can offer more advantageous terms and higher amounts.
- Unsecured Loans: Loans requiring no collateral. Unsecured loans are usually harder to obtain than secured loans and come with higher fees and lower amounts.
- SBA Loans: The Small Business Administration (SBA)[4] is one of the best-known government loan providers that specializes in microloans, smaller loans for lower amounts, usually a maximum of $35-50,000.
The SBA partners with intermediary lenders such as financial institutions on loans up to $50,000. SBA microloans can be put toward working capital, inventory, supplies, and more, but may not be used for debt repayment or purchasing real estate. These loans are the easiest loans to apply for with fewer requirements and qualification criteria than most other loan types.
The SBA also offers larger loans for long-term financing, construction, and large purchases such as real estate and heavy equipment.
When applying for a small business loan, lenders will most likely consider the following factors:
- Business size and industry
- Personal and business credit scores
- Average annual revenue and sales
- Financial and payment history
- Assets for collateral
Business loans may be a good fit for small business owners looking for working capital to expand their businesses or freelancers if they are sole proprietors or single LLC owners.
How to Apply for Loans
Now that you have a better understanding of the loans available to self-employed workers and the additional requirements they face, follow these four steps to begin your funding journey.
1. Determine your funding needs and financial situation
Start by assessing the state of your personal and business finances. Look at your income, sales, any debts, operating costs, cost of goods sold (COGS), and recent tax returns to get a sense of your financial health and cash flow.
Although you won’t be able to predict exactly what each lender will look for, having a better grasp on your finances will help you gain clarity around the type and size of the loan you’ll need.
Then make a list of preferred loan terms, including:
- Loan need, whether more specific (i.e. equipment or real estate) or more general (capital, operating costs, etc.)
- Ideal amount and interest rate
- Preferred monthly payment and repayment term length
2. Check for pre-qualified offers
Banks often give precedence to current customers when it comes to loan applications due to their established banking and credit history. Research loans at the financial institutions you already have personal or business accounts or credit cards with for a potentially quicker and easier approval process.
3. Shop around to compare terms and lenders
With a clearer idea of any offers you may already qualify for, start researching loans and lenders further afield, paying special attention to lenders that offer loans for the self-employed. Compare your current bank’s loan terms with other well-known institutions and organizations such as larger banks, smaller local banks, credit unions, and the SBA. This will help you narrow down your options and help you make an informed choice.
4. Gather your financial information
Next, create a digital or physical folder for loan documentation, including any tax statements from the last 2-3 years, bank, and financial statements. Be sure to check what documentation each bank requires for self-employed applicants, which may involve additional research or speaking to a banker directly.
3 Tips to Help You Get Approved
Once you have done your due diligence and have a short list of potential lenders and preferred loans, you’re ready to begin applying. Here are a few tips to increase your chances of submitting a successful loan application.
1. Apply with your highest credit score
While most freelancers and independent contractors may only have one personal credit score, many small businesses have a separate, business-only credit history. This business credit score can be tracked through free reports from services such as Dun & Bradstreet[5].
If you have a business as well as a personal credit score and one is lower than the other, consider applying with the higher of your two scores, if your lending bank allows it.
2. Consider a secured loan
Need a larger loan? Look for funding sources that must be backed up with assets such as a savings account, vehicle, real estate, or equipment, as collateral. If you have limited credit history, lower taxable income, or irregular income, a secured loan may help you acquire a better interest rate.
3. Opt for a microloan
Another way to make the approval process easier is by choosing a smaller loan with fewer eligibility requirements. Provided that your financial need is less than $50,000, a microloan may be the best option. Lenders like the SBA partner with banks nationwide to offer microloans, so you could still work with a financial institution you’ve done business with before.
Loan Alternatives
Applying —and qualifying for—a bank loan requires a few extra steps when you’re self-employed. Depending on your needs, resources, and timeline, it may be wise to have a backup plan, especially if you need funding quickly.
Here are some alternate solutions you might consider as a last resort:
Business or personal credit cards: Similar to loans, personal credit cards can be used for a variety of expenses, while business credit cards are limited to business-related expenses. Advantages include cashback rewards, redeemable points, and merchant discounts.
Cash advances: A short-term loan offered by your credit card issuer that allows you to withdraw cash up to your credit card limit. Cash advances are not recommended as they come with hefty fees and can have much higher rates than loans.
Lines of credit (LOC): A type of loan that uses revolving credit, commonly used for short-term expenses or operating costs. LOCs give you access to cash up to a specified limit. Once approved, you may borrow any amount up to that limit as needed.
Home equity lines of credit (HELOC): This line of credit borrows against the equity of your house. HELOCs usually have lower interest rates than most other loans and credit cards and may even be tax-deductible in some cases.
Keep in mind that these alternatives work best for short-term cash flow and may not be the best choice for long-term funding.
Need help finding a loan as a self-employed person? At PNC Bank, we offer a wide range of funding options, from personal loans and HELOCs to secured and unsecured small business loans.
Learn about PNC Personal Loans
Learn about PNC Small Business Loans
