Loans are a valuable source of financial support for individuals looking to fill funding gaps in their businesses and grow their ventures. While securing a business loan is quite simple today, self-employed individuals still face several challenges when it comes to obtaining a business loan for the self-employed. From freelancers and independent contractors looking to build their business to professionals seeking credit to establish independent practices, obtaining a self-employed loan involves jumping through various hoops. This article outlines the main challenges faced in securing self-employed loans and highlights a few handy solutions to tackle these problems.
What Does “Self Employed” Mean
Before we proceed to discussing the challenges faced by self-employed people in taking a business loan, let’s understand the meaning of a self-employed individual. According to the Income Tax Act of 1961, a self-employed individual is a person who sells his services to various businesses without having a long-term contract or is engaged in business of trade, commerce, manufacturing, or other related activities. Individuals like doctors, lawyers, and architects, who pursue specific vocational specialisations are also termed as self-employed individuals.
Primarily, self-employed people can include freelancers who work for themselves that work on commission-based projects with multiple organisations simultaneously and small business owners. Every small business owner who owns a sole proprietorship, limited liability corporation, partnership firm, or corporation is classified as a self-employed individual. Now let’s understand the common problems encountered when you are looking for loans for freelancers and self-employed loans.
Why Loans for the Self Employed Can Be a Challenge
Generally, obtaining a business loans for self-employed people is a challenge, primarily due to the following reasons:
Proof of Income
Self-employed individuals typically need to submit substantial income proof documents compared to traditional salaried individuals seeking credit. Lenders scrutinise both the business financials as well as bank statements, personal ITRs, and other such documents of the self-employed applicants to verify their income.
Income Inconsistency
Lenders prefer applicants with a stable income stream because a consistent income assures the possibility of timely repayments and lower default risks. Securing a business loan for self-employed people is often a hassle primarily because of income inconsistencies. Income of self-employed individuals like freelancers rise and fall inconsistently throughout the year, making them riskier borrowers. To obtain a loan for the self-employed, they need to prove creditworthiness and consistent income to the lender.
Minimum Experience
If you are a self-employed working professional like a lawyer or a doctor, securing a loan for the self-employed can be a challenge due to minimum experience requirements. Many lenders require a minimum years of professional experience before you can apply for the loan to ensure that you have a stable practice and consistent cash flow. Securing a loan for self-employed people can be a hassle if you have just started your business or are planning to establish a stand-alone practice.
How to Apply for Loans
Now that you understand the challenges faced by the self-employed to obtain a business loan, we can proceed to the steps you can take to make this process easier. If you are looking for a loan for the self-employed, you can follow these steps to ensure hassle-free applications:
- Determine your funding requirements: If you are about to apply for freelancer loan or business loan for the self-employed, you must first ascertain your credit requirement. Identifying the purpose of the loan can help you narrow your requirement. For instance, if you are borrowing the funds to expand your business, you can estimate the cost of leasing a new property, funding new equipment, hiring new staff, and running overheads like utilities. Understanding your costs will help you determine how much funding you need to cover these expenses.
- Check for pre-approved offers: Banks generally extend pre-approved offers to existing customers. If you already have a working relationship with a lender, try approaching them for a self-employed business loan. Based on your existing relationship, the lender may be willing to offer pre-approved business loans if you have been a responsible borrower.
- Compare interest rates and offers: Research and review interest rates offered by lenders that specialise in self-employed loans. Compare rates and loan terms to ensure you have access to a business loan for the self-employed on the best possible terms.
- Create a document checklist: As mentioned earlier, self-employed loans generally require more documents. As a self-employed applicant, make sure you have a handy document checklist in place to avoid processing delays and rejections. Check what documents the lender requires for self-employed individuals and prepare your checklist accordingly.
Three Tips for Loan Approvals
Apart from the handy strategies mentioned above, you can utilise the following tips to ensure swifter self-employed loan approvals:
- Maintain a High Credit Score
One of the best ways to obtain an unsecured self-employed loan is to maintain a high credit score. Your credit score is a three-digit number ranging from 300-900 that indicates your creditworthiness and determines your loan eligibility. You can boost your credit score by utilising simple credit health practices like timely repayments, maintaining a low credit utilisation ratio, and avoiding loan defaults. A high credit score helps assure the lender of timely repayments, even if you have inconsistent income. Credit scores above 750 are especially favourable for those looking for unsecured self-employed loans.
- Consider a Secured Loan
If you have a low credit score or irregular income, you can still obtain a self-employed business loan. However, most lenders may need some extra repayment assurance before sanctioning the required credit. In such cases, you can obtain a secured business loan by pledging assets like personal or commercial property, machinery, business equipment, or accounts receivable as collateral.
- Opt for a Microloan
You can also consider short-term microloans to finance smaller capital requirements. Microloans are available to self-employed professionals, small businesses, start-ups, and micro enterprises through government-backed small finance banks and specialised microfinance institutions.
Alternatives to Consider
While business loans are some of the best loans for self-employed people, obtaining such financing for your enterprise can be challenging. The tips outlined above can help you eliminate some of these challenges, but you may still fall short of the lender’s requirements. That’s why, it’s essential to consider the following self-employed loan alternatives:
- Lines of credit – A line of credit is a form of revolving credit where the lender offers you a certain credit limit. You can withdraw funds from the account up to the preapproved credit limit to meet various short-term operational costs. Interest is only charged on the borrowed sum.
- Personal loan: Personal loans for the self-employed can be handy tools to finance your business needs when securing a business loan is too difficult. These unsecured loans can offer you flexibility of usage.
P2P lending: Another great self-employed loan alternative includes peer-to-peer lending. P2P lending platforms are designed to offer customised funding to self-employed people and small businesses at relatively pocket-friendly rates.
