Getting approved for a loan when you don’t have a traditional job feels like trying to get into a club when you’re not in the know on the secret handshake. Banks and lenders have been at this game for decades creating their approval systems based on W-2 employees all with predictable income, and anyone who’s doing it outside of the standard box gets additional scrutiny.
Freelancers, contractors, gig workers and small business owners know this pain all too well, they may actually bring in more income than the average W-2 employee, but then getting the lenders to see that becomes a part-time job of its own.
That’s the greatest issue, between what’s actually brought in and what’s proven by paper. An employee provides two pay stubs and basically, they’re done. A self-employed person has to provide tax returns, bank statements, profit and loss statements, potentially more documentation to get them looking like they’re under a microscope. But the good news is, it’s not impossible to get approved; it’s just important to learn what lenders need to see and why it might not make sense to conventional thinking.
Why Lenders Have Difficulty with Self-Employed and Irregular Income
Banks have models built on risk assessment, and for decades these models have been created around the idea that most people work for one employer with predictable income. So if anything looks out of place, the system denies before it investigates. Therefore, multiple sources of income on the same application is red flag territory; variable incomes look better on a pie chart than they do on paper. If someone has $4,000 one month; $3,500 the next; $4,600 the next – but their anticipated monthly payment is only $500 – it looks like they’ll have trouble making payments six months from now when their cash flow isn’t as certain.
However, it gets worse, many self-employed men and women write off legitimate business expenses that ultimately reduce income, as in, a contractor may make $80,000 gross, but after writing off materials expenses and other things, they show a net income of $45,000. This is also in line with what lenders typically use, net income for qualification purposes which severely reduces borrowing power.
In addition, traditional banks are slow. Lenders typically have underwriting departments that may look at applications by hand and if something appears with a red flag it gets kicked up to senior underwriters who take even more time to make a decision. For someone looking for quick funding, this isn’t often the answer.
What Lenders Are Actually Looking for Aside from Paystubs
For self-employed borrowers, lenders who want income verification mostly rely on documentation and third party assessment to verify an ongoing ability to earn. Most lenders want 2 years of tax returns (not just the 1040 form, but a full return), the IRS wants to see if you’re a sole proprietor or if your LLC or corporation has been making enough money to support a salary.
Then lenders will want 3-6 months’ worth of personal bank statements and personal business bank statements. They want to see deposits coming in and they’re going to compare what they’re seeing with your business tax returns to see that this money is being deposited per your claims, not that it’s just been sitting there forever or that it’s not legitimate work. They’re looking for consistency amongst industries; they don’t want to see a landscaping deposit in January; an electric deposit in February; a medical deposit in March unless that’s actually part of your work.
Then lenders want a profit and loss statement as it’s more reputable if it’s compiled by an accountant than an applicant themselves, but some will accept self-prepared applications if the loan is under $50,000. This statement gives a current snapshot of revenue streams, expenses (deductions) and net profit within whatever time frame you’ve been eligible up until now; lenders are looking back at taxes that are always months out since they’re based on the calendar year.
In certain circumstances it’ll help to have additional documentation as 1099s from large clients, contracts for future work (projects started but not yet completed) or letters from clients who’ve worked with you for many months or years expressing satisfaction will help show that what you do is legitimate, sustainable business, not just random income streams over time.
Who Else Is More Likely to Help Self-Employed Persons
Not all lenders operate under the same standards/laws/compliance like banks do. Online lenders, credit unions and specialized platforms have made adjusting their underwriting processes easier for life in this day and age. Platforms like Smarter Loans allow individuals to connect with lenders who assess loans based on different qualification efforts beyond pure W-2 employment assessment.
These alternative methods often use different types of qualification. Some will rely heavily on bank account access – meaning they’ll require view-only opportunities into your bank statements so their algorithms can assess deposit patterns better than what’s presented on paper. Others will focus heavily on credit score and payment history over meticulous income documentation and some specialized lenders deal only with specific professionals (real estate agents, truckers, medical professions) who understand the patterns typical for such endeavors.
The trade-off is usually higher interest than through conventional loans, but if you’re self-employed and there’s no other way for you to get approved at least 1%-2% higher is preferable over getting denied.
How to Put Your Best Financial Foot Forward
When it comes time to document everything regarding income verification rather than self-employed borrowers getting easier abilities than W-2 employees, that’s not the case. Thus, it’s even more crucial for self-employed applicants to ensure their documentation quality puts their best foot forward.
For example, you can’t have your taxes be arbitrary, if you are missing years (have not filed or are operating under extensions), you need to figure this out before applying for major loans. If you don’t have taxes that lenders can work with, they won’t be able to work with you.
Bank statements need to be accumulated chronologically, if you have numerous deposits from small projects don’t worry, the lender will highlight large deposits, but if you want, you can provide an Excel spreadsheet accounting for monthly income from your bank statements as long as it’s cohesive. The easier it is for an underwriter to understand your situation without figuring it out on their own, a supportive approach helps.
Consider timing your application if you’ve just completed a great earning quarter or year – apply then rather than waiting until things die down. It’s always what’s recency bias; therefore, more interest will be paid to what’s most current,
If you’ve got significant deductions that hinder your taxable income – partnering with mortgage brokers/loan officers who operate primarily with self-employed clients is in your best interest. They know which lenders pay attention to gross income without subtracting deductions or which ones will add back certain deductions without question to increase qualifying income.
Credit Score Matters Even More
When self-employed borrowers have complicated documentation situations, lenders lean heavily on credit history as risk indicators. So even if you’ve got exactly $XX income with your W-2 counterpart, if you have a credit score of 760, you’ll get approved much easier than if you’re comparable applicant had a 620, even if both incomes are the same.
Therefore, this means self-employed persons need to go above and beyond about credit management, pay everything on time without fail; have low credit card debt with high credit; don’t apply for loans when you’ve got upcoming (within the next three months). The credit score will act as collateral for loan approval when the income documentation may not be as clear cut as someone who just provides their pay stub.
It’s also crucial before applying for loans that self-employed borrowers check their credit reports across all three bureaus ahead of time, it helps prevent ugly surprises. Mistakes happen; but if there’s something ugly found after applying, it raises red flags and creates delays during the application process, and no one wants that.
When Co-Signers or Collateral Considerations Help
Some self-employed individuals are able to approve their loans easier by adding co-signers who are traditionally employed. If there is someone who lives in the same household, a parent, spouse or family member who’s willing to co-sign their loan, they can bring their W-2 income documentation which creates less financial red flags, but then unfortunately puts that person responsible for repayment as well, which poses personal relationship issues.
Collateralized loans help when those who’ve been denied due to income verification have specific items or securities which can help mitigate potential losses, that certain assets provide value that the lender can take back should everything go south reduces risk assessment from other angles for income repayments. You’ll still need to show ability but less stressing circumstances emerge when collateralized backing exists.
How Future Self-Employment Creates Better Approval Odds
Self-employed persons who plan ahead over time obtain better odds down the line for future financing endeavors – keeping business finances separated from personal reduces documentation effort while having year-round records instead of last-minute piles at tax season create better financial statements over time. If accountants are used early, they will understand how financial efforts help lending efforts with structured plans that meet both interests.
Finally, the longer someone has been self-employed with consistent income streams/the easier it is for approvals, the more time there exists raises red flags only. If you’ve only been freelancing for six months, lenders get nervous, but if you’ve had five years of consistent results supported by significant documentation, they’re much less risky, even if income varies from seasonally or project-completion based strategies.
Getting approved without hassle when you’re not employed, the ideal situation, or without consistent income as an employed peer requires more prep work and better documentation efforts than conventional clients, but it’s certainly possible. It’s important for borrowers to recognize that they’re playing a game that wasn’t made for them so they need to translate their realities into systems that make sense, for others, and then appeal their efforts through presentation efforts, lender selection processes and strategic planning so lenders recognize irregular income as just one factor among many instead of a deal-breaking complication.