Being your own boss or working in a job that pays commission can have wonderful benefits. But there are also trade-offs; getting a loan, for instance, can be more difficult when you have an unsteady income. Here’s what to know about getting a loan when you don’t have the steady income that comes with a typical 9 to 5.
PROVING YOUR INCOME
When you apply for a loan, a lender will calculate your debt-to-income ratio (DTI). Your DTI is a comparison of how much money you make each month with how much you already owe on debt. So, if you make $4,000 each month and you have $1,000 in debt payments, your DTI is 25 percent. Lenders generally prefer that your DTI is below 43 percent — although some might want it to be no higher than 31 percent.
If you have a steady job that pays you a monthly income, calculating DTI is easy; it gets more complicated when you have unsteady income. In that case, a lender will likely want to see a longer history of earnings to get a better sense of what your income is over time. The lender will also look at whether that income seems to be steady, increasing or decreasing. Declining income may prevent you from getting a loan.
WHAT THE LENDER WILL LOOK AT
If you have irregular income, you’ll have to do a little extra leg work and provide more financial information than would typically be required to get a loan. That could include providing two years or more of W-2 forms and/or bank statements.
If you want your lender to count bonus income, overtime income or part-time income, you will likely need to prove that your income from these sources has been consistent or rising over the last two years. The lender may also want your employer to say that this income is likely to continue for the next three years. If the lender decides to count this income, they’ll average the amount you’ve made from these sources over the last two years to get a monthly average. If these sources of income are decreasing, your lender might decide not to count them at all.
If you own your own business, a lender may also ask for bank statements, tax returns or something known as form 1088, which shows the lender your income for two years. Also, if you have personally signed for business loans, those will count toward your debt-to-income ratio.
STEPS TO INCREASE YOUR CHANCES OF GETTING A LOAN
If you know you’ll have unsteady or irregular income, there are some things that you can do in order to increase your chances of getting a loan in the future.
Take fewer tax deductions. Who doesn’t want to keep more of their money? You don’t, if you want your taxable income to appear higher to a lender. Skipping some deductions could be particularly helpful if, with the deductions, your income seems to be declining.
Maintain or improve your credit score. This is true for anyone looking to get a loan. But if you’re going to undergo extra scrutiny because your income is uneven, it’s helpful to improve your score as much as possible. Having a higher credit score can help you qualify to borrow more money or to borrow at a lower rate.
Get a Co-Signer. Adding a co-signer with a more-steady income can make a lender more comfortable approving your loan. But that person will be on the hook for the loan if you’re unable to pay it.
Pay off other debt first. Getting rid of other debt will reduce your DTI, which can make it easier to get a new loan.