Applying for personal loans can involve a lot of red tape under normal circumstances. Applicants who are searching for personal loans and are self-employed or have income from freelance work or consulting gigs may find that they will encounter a few additional challenges. To simplify the process and get the best loan rate possible, applicants should know what the requirements are, and what type of loan is best for their needs.

Self-employed loan requirements

One of the first and most important steps in applying for personal loans is to produce documentation to verify income. 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.

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.

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 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.

Because there are additional requirements for self-employed borrows, they should prepare to file more paperwork than other borrowers. For example, a self-employed borrower is generally required to provide several years worth of income documentation.

According to Mary Monroy, credit counselor with ClearPoint Credit Counseling Solutions, “The lender will likely require the most recent two 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.”

To make matters more complicated, most lenders also require prospective borrowers to show income consistency. That means the borrower must prove that they are making a consistent amount of money on a monthly basis to be eligible for a loan. Providing income generated from a “side hustle” that only brings in a small amount of money here and there may not count towards actual income.

And like all loan applicants, the borrower will need to pass a credit check before they can get approved. Some lenders require borrowers to have a minimum credit score in order to get approved for a loan. Others are more lenient in credit requirements, but will offer a higher interest rate or cap the loan at a lower amount.

Although it’s not a requirement, it can be much easier for self-employed applicants to get approved for a loan if they have a cosigner. That shows the lender that the applicant has financial backup in case their business goes under, or are unable to pay back their loan in full. Having a cosigner can also help the applicant negotiate a lower interest rate or higher loan amount based on their needs.

An altnerative option: Business loans

Another loan option for self-employed applicants is to get a business loan, which has both upsides and downsides. A business loan can be beneficial to self-employed people because it separates their business expenses from personal finances. When it comes time to file taxes, having those finances separated can make the tax filing process much simpler.

In fact, a business loan might actually be a better option if the applicant was considering a personal loan for business use. But applicants should keep in mind that a business loan can only be used to cover business-related expenses. If the applicant was planning to use 50% of a personal loan for personal expenses, and the other half to cover business costs, they won’t have the same flexibility with a traditional business loan.

In most cases, a self-employed applicant can get approved for a business loan at a higher amount than they could for a personal loan. Business loans can be used to cover any business-related expenses, but are often used to pay for general operating costs, equipment costs, real estate costs, merchant cash advances, lines of credit, franchise costs and so on.

To apply for a business loan, there is actually more paperwork that needs to be filed than for a person loan. The applicant must submit their business finance statements, proof of income, profit and loss statements, projected financial statements and tax returns. The business owner will also have to submit their loan application history, if applicable.

But just like with a personal loan, a self-employed applicant will only get approved for a business loan if the business has adequate credit. Generally, it takes several years for a business to get to a point where it has credit that is favorable to a lender. And depending on the situation, the applicant might have to give a personal guarantee for the loan, which means they would be personally liable if the business couldn’t repay the loan.

The bottom line

Despite the hurdles associated with personal and business loans as a self-employed applicant, it’s still entirely possible to get approved, even without a W2 pay stub. According to Dervan, potential applicants should 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.

Before the applicant visits their lender, they should have the necessary paperwork organized and ready to go. The more documents they can show, the better they can prove their income. Starting off with a good credit score is also a huge help, as is applying with a cosigner.

Before applicants choose a lender, they should shop around and find a company that specializes in self-employment loans. Specialty financial institutions are better equipped to guide self-employed people through the loan process, and a lender may be more likely to approve a loan with favorable terms.

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