Debt consolidation for self-employed borrowers

Self-employment could give you freedom that you may not find in a traditional 9-to-5. On the other hand, you may have to deal with some quirks too—like extra headaches at tax time or unpredictable income.

You might rely on credit cards to help cover expenses in lower-income months or while you wait for clients to pay up. At some point, you might think about consolidating your debt with a loan so it's easier to manage. 

Self-employment could add a wrinkle when you apply for loans, since you might have to work a little harder to show a lender you're creditworthy. Here's how to get a debt consolidation loan when you freelance, do gig work, or run a small business. 

Can self-employed people get a debt consolidation loan?

Yes, lenders may offer loans to people who are self-employed just like they do for people who have traditional jobs. What could be different is the kind of hoops you need to jump through to get approved. 

Let's backtrack a little. First, what is a debt consolidation loan? 

In simple terms, it's a loan you take out to pay off other debts. For example, you might get an unsecured personal loan or a home equity loan to pay off credit cards, medical bills, vet bills, and other debts. Once you pay off your other debts, you just have to repay the consolidation loan with interest, according to the schedule set by your lender. 

Self-employed debt consolidation loans are loans for people who don't have traditional employment income. There could be some benefits to debt consolidation for freelancers and self-employed people, including:

• Simplified budgeting. When your income goes up and down, you may find it harder to make a monthly budget or keep up with multiple debt payments. Consolidating your debt could mean you only have one payment to make each month versus several.

• Interest savings. Credit cards are convenient, but they can be costly too if you carry a balance with a high interest rate. A debt consolidation loan could save you some money on interest if you qualify for a lower rate. 

• Build credit. On-time payments to a debt consolidation loan could help improve your credit score. You might appreciate that credit boost later if you need to apply for a small business loan, or if you want to get a mortgage to buy a home. 

Common challenges for self-employed applicants considering debt consolidation

When you're self-employed, debt consolidation isn't always a straight line. You may need to overcome some hurdles to get a lender to approve you for a loan. Here's what could raise eyebrows with lenders. 

• Irregular income. The fact is that while self-employment means freedom, it doesn't always mean a steady paycheck. Your income is often tied to how many clients or gigs you book, and you might not get paid on the same schedule from month to month. That could make it harder to show a lender you have consistent income and can repay what you borrow on time. 

• Income verification. A lender might ask you to go back further to show your income or self-employment history for a debt consolidation loan. Instead of one year of tax returns, for example, you might need two. Or you might need to show profit-and-loss statements, cash flow statements, or bank account statements to prove that you're financially stable. 

• Perceived risk. Some lenders view self-employment as a bigger risk factor compared to someone who works a regular job. You could still get approved for a debt consolidation loan, but you might pay more for it if the lender decides to charge a higher interest rate to offset the risk. 

Aside from those challenges, having a mix of personal and business debts could complicate things. Some lenders may state in the loan agreement that you can't use a personal loan to consolidate business debts. 

If you plan to get a home equity loan, remember that it's secured by your home. Your lender may not care if you use the loan to consolidate business debts, but you risk losing your home if you can't make the payments. 

Debt consolidation options for self-employed borrowers

We've already mentioned personal loans and home equity loans for debt consolidation, but what's the difference? Here's what you should know. 

• Personal loans are loans you can use for personal reasons, like debt consolidation. 

• Most personal loans are unsecured, so you don't need collateral (something of value you own that backs up the loan) to qualify. 

• A personal loan could work well if you have proof of stable income, even if that income isn't exactly the same each month. 

• Home equity loans and HELOCs (home equity line of credit) can also be used to consolidate debt if you qualify. 

• Home equity loans are secured loans that use your home as collateral. Secured home equity loans are lower risk for the lender and typically have better interest rates than unsecured personal loans.

• You'll need good credit, steady income, and enough equity in your home to meet the lender's qualifications. Home equity is the difference between what you owe on your home and what it's worth. 

• Repaying a home equity loan or HELOC requires a solid plan and dedication since you could lose your home if you don't pay your loan. 

For either type of loan, consider looking for a lender that specializes in working with people who are self-employed. These lenders should know how to evaluate your credit history and 1099 income for debt consolidation approval. They often understand the unique financial circumstances that go along with self-employment. 

Tips to improve approval chances

If you're self-employed, loan approval isn't out of reach. A little strategy could go a long way to improve your approval chances. Here's how you could strengthen your case.

• Separate your finances. Keeping business and personal finances separate is a smart practice in general. When you file taxes, for example, it can help to have a clear paper trail that shows your business expenses so you can deduct them. Separating expenses and income could make it easier for a lender to get a handle on how much money you have and where it goes. 

• Show consistent income over time. The amount of money you make matters, but lenders also look at how regular your income is and how long you've been earning from self-employment. It could help to have bank statements or business records that show steady income over the last one to two years. If you can prove your income is rising over time, that could be even better. 

• Consider a co-borrower. If you're worried you can't get a loan by yourself because you're self-employed, you might ask someone to co-sign. A co-signer or co-borrower could apply for the loan with you. That could make it easier to get approved if they have a steady income and a good credit score. 

Alternatives if you're denied

You've done all the right things, but you're denied a debt consolidation loan. So what do you do next if you still need debt help?

First, ask the lender why you were denied. Their explanation may shed some light on why you weren't approved and what you might improve on to get approved in the future. 

After that, consider alternatives to debt consolidation. Your options could include:

• Debt relief. Debt relief is a way to get rid of debt for less than what you owe. You offer creditors a reduced amount, and if they agree to accept it, the rest of the debt is forgiven. A professional debt relief company could help you negotiate. You might consider this path if you owe more than you can afford to repay.

• Debt management plan (DMP). A debt management plan is a structured plan to pay off debt that you set up through a credit counselor. You make one monthly payment to a special account through the credit counselor. It’s then used to pay your creditors. You don't need good credit to get approved, but you might need a minimum amount of debt to qualify. DMPs tend to work best if you can afford your debt but need guidance to repay it.

• Creditor hardship program. Your creditors may be open to negotiating your repayment terms if you need help. For example, you might work out a different payment schedule if your income from self-employment is higher at certain times of the year. Or you could ask for interest rate reductions so that more of your payment goes to the principal. This typically works best if you are current on your payments.

• DIY payoff. The debt snowball and debt avalanche are two ways to pay off debt without a loan or any outside help. With the debt snowball method, you order your debts from the smallest balance to the highest. You pay as much as possible to the smallest debt each month and make minimum payments to the others. Once you pay off the first debt, you roll its payment to the next debt on the list. You keep doing that until your debts are gone. The debt avalanche method works the same way, only you pay off debts from the highest interest rate to the lowest. 

Your income and goals could guide you toward the right debt solution. What's most important is that you choose a debt repayment option that you can fully commit to. 

What's next 

• Check your credit scores and reports to get an idea of how risky you might appear to a lender. 

• Compare rates for personal loans vs. home equity loans or HELOCs, if you own a home. 

• Review your self-employment income for the last one to two years. Look at how your income has changed over time, and how much you bring in monthly on average. 

• Talk to a debt specialist about the best ways to handle debt when you're self-employed.