Getting a business loan is not easy for most people, but if you are self-employed it can be even harder. When you are self-employed, you may not have:
- A steady income.
- Real property or inventory to use as collateral.
Lenders prefer borrowers who have a steady income or plenty of property for collateral because it reduces their risk. Someone who is self-employed does not present as a good risk because the individual may have inconsistent cash flow income or periods without work.
The guidelines for getting a business loan if you are self-employed vary somewhat depending on the type of loan you are applying for and how much money you need. Whether you are applying for a mortgage, a consolidation loan or a business loan to grow your business, there are steps you can take to increase your odds of getting the loan you want even if you are self-employed.
Have Two Years’ Proof of Income
When you are self-employed, you do not have pay stubs you can show a lender if you are applying for a loan. You also may not have any tangible business assets such as inventory or equipment to use as collateral. The lender wants proof your income is steady, and a stack of 1099 forms do not do the trick. You need to provide your tax returns for at least the last two years to prove you have a reliable income meeting a minimal standard for the loan.
Because of the higher risk, lenders may request additional information about your business. Having an income statement, copies of your balance sheet, a revenue statement and a report of your expenses can all help paint a more accurate picture of your ability to repay a loan.
Build Up Your Bank Account Before Borrowing
If you want to borrow a significant amount of money to improve and grow your business, having a few thousand dollars saved can make a difference. It shows lenders you have some reserves to cover monthly payments in case you have a few lean months. This also protects you from having to default on your business loan if you lose a major contract or have to take some time off.
Pay Off as Much Debt as Possible
It takes more preparation to apply for a business loan if you are self-employed, and there is no way around it. It is crucial to minimize your current debt before taking on more debt. Lenders do not give a business loan to you if they feel you are already overextended. Pay off as much business debt as you can so your cash flow is improved. Pay off as much personal debt as you can, as you may end up having to apply for a personal loan if you cannot get a business loan approved.
Focus on Your Business Credit Score
A business credit score is not the same as a personal credit score. If you are applying for a business loan, check your business credit score several months before applying so you can address any discrepancies and improve your score by bringing any accounts current. The three main agencies compiling business credit scores are Dun & Bradstreet, Experian and Equifax.
Check with them to see if your business is registered and what your report says. Most of these charge a fee, but there is a business version of Credit Karma, called NAV, that works on the same principal. It can give you a good idea of where you stand.
Making payments on time to creditors and vendors is the single biggest factor in determining your business credit score. If you have credit cards, business lines of credit or other finances in place under your business name, you will have a business credit score ranging from 0 to 100.
If you do not yet have any credit with vendors or a business credit card, it is a good idea to get one for several reasons:
- It is easier to get a business loan when you are self-employed if you have a good business credit score.
- You are be able to borrow more on a business loan if you have good business credit.
- A good business credit score can get you a lower rate on business insurance.
- You are keeping personal and business finances separated. This protects both you and your business in the event there is a default on a loan.
- It is easier to track business expenses.
Look Into SBA Microloans
The Small Business Administration (SBA) guarantees some business loans made by selected banks, nonprofits and alternative lenders. The guidelines are strict for many of these and they are usually offered to individuals with already established small businesses or who offer some form of collateral.
The SBA does offer a microloan program that can be helpful to the self-employed. These are loans of no more than $50,000 the administration partially guarantees, allowing lenders more freedom to loan funds to sole proprietors and other self-employed individuals.
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SBA-backed microloans are geared toward entrepreneurs and those who have suffered economic setbacks. They focus on startups, underserved markets and minority entrepreneurs, with the typical microloan being in the $15,000 range. This is enough to improve cash flow without creating monthly payments that are out of reach for borrowers.
Consider Invoice Financing
Invoice financing, also called accounts receivable financing, is an option for you if you regularly have outstanding invoices that are not paid for thirty to sixty days. You essentially borrow funds against the outstanding invoices. This is a short-term business loan to help improve your cash flow and keep current on vendor payments while giving you some funds for growth. You pay a percentage of the invoice amounts to the lender in exchange for their cash advances. If you are having difficulty getting a business loan, invoice financing can help you get over the hurdle of clients who drag their feet paying you after you have completed projects.
Invoice financing is a good alternative to more traditional business loans if you are self-employed and do not have any capital to use as collateral or you have not been in business for two years or more. Risk is minimized because you do not borrow more than you anticipate earning. Keep in mind, however, that if a client does not pay an invoice, you are still expected to pay back the loan made against it.
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