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Applying for a personal loan when you're self-employed

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By Jean Chatzky

Applying for personal loans can involve a lot of red tape under normal circumstances. But applicants who are self-employed or have income from freelance work or consulting gigs may find that they will encounter a few additional challenges.

One of the 1st steps in applying for personal loans involves producing documentation to verify the applicant's income.

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This is a pretty straightforward process for someone who works for an employer, as they would usually just need to provide copies of recent pay stubs. Some lenders can even verify income electronically through an employer's payroll system, further simplifying this process.

However, would-be borrowers who aren't on an employer's payroll will need to produce other documentation, proving their income. The exact documentation required can vary by lender, but generally it will involve tax records and/or bank statements.

More paperwork required

"The lender will likely require the most recent 2 years' tax returns, a profit and loss statement and bank account statements to verify the income is seasoned. If it isn't, then sometimes copies of deposited checks are required," says Mary Monroy, credit counselor with ClearPoint Credit Counseling Solutions.

For some personal loan applicants, the amount of paperwork required can come as an unpleasant surprise. Susan Ladika is a Florida-based freelance writer who considered applying for a personal loan after receiving a tempting offer from a lender.

"I get solicitations all the time, but I was intrigued by this one because the rate was really low. I thought of borrowing about $5,000 or $10,000 to pay off a credit card bill and get some work done around the house," Ladika says.

The lender's website didn't provide details about income documentation required for self-employed applicants, so Ladika contacted the customer service department.

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"When customer service responded that I needed to upload 2 years' worth of tax returns with all schedules, I told them to forget it. It's not like I'm a 23-year-old with a simple tax return," she says. "It wasn't worth it to me to scan and upload pages and pages of documentation for that small amount of money."

2 years of income documentation

Chris Dervan, senior vice president and product manager at PNC Bank, said income verification is a standard requirement for all loan applications, regardless of the specific income sources.

"We require income information and documentation for all applicants, so in that respect there's no difference for self-employed borrowers. The variation would be in the type of documentation involved with those who don't have a pay stub," Dervan says.

Dervan said lenders generally require 2 years of income documentation, which, for applicants without pay stubs, would most commonly be proven via tax returns, but he added that the main goal is to see that they have reliable income and a steady history of earnings to show that they can repay this loan.

Applicants can help the process go more smoothly by being prepared with organized copies of their relevant paperwork. "For any type of borrower, the application process will be easier if they have good records and documentation," Dervan says.

Business loan vs. a personal loan

He says one thing self-employed applicants may need to keep in mind is the difference between gross revenue and net income.

"They may think in terms of their gross income but also need to consider the deductions and expenses that may offset that income. The income we would consider would be closer to the net income," Dervan says.

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Depending on their plans for using the proceeds of a personal loan, Dervan says self-employed applicants may want to consider whether they might be eligible for a business loan instead.

"That actually may be a better option for them, if they were going to be using these funds for business-related expenses," he says.

While some applicants may see these income verification paperwork requirements as a headache, Dervan says that these policies are designed for their protection. It's in the borrower's best interest to ensure he or she is capable of making the payments on a loan before committing to this obligation.

Also, Dervan wants potential applicants to know that lenders encourage those with self-employment or freelance income to apply for loans, and explore the various loan options that may be available to them.

"We welcome self-employed applicants and will do everything we can to work with them to help them obtain a loan," he says.

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