The Covid-19 pandemic affected economies in different ways. Many people are now self-employed, with a good number earning through freelancing. Yet another group depends on others to pay them and are generally termed as contract workers. The self-employed and contract workers face the same challenge; securing a car loan.
While people on traditional employment may secure the loan smoothly, the self-employed and the contract workers may find it a bit rough. However, rest assured that you can get a car loan, provided you meet lenders’ requirements.
Here is all you need to know about applying for a loan when you are self-employed or a contract worker.
Why do the self-employed and contract workers find it rough when applying for a car loan?
In reviewing your car loan application for possible approval, the bank and other potential lenders usually want to see proof of steady income to ensure that you can repay the loan. Of course, that’s a non-problem for anyone on a paycheck, and sometimes, those on W-2 arrangement. However, having proof of steady income may be hard if you are self-employed, freelancing, or a contract worker.
The good news, though, is that there are provisions that cater to self-employed people, and the lenders will bank on these to verify your creditworthiness. For instance, most lenders will request the borrower to present proof of self-employed tax returns for the last two years, and having it may help you stand a chance of getting the auto loan.
Moreover, claiming too many deductions may lower your creditworthiness, which you will only realize when requesting a car loan. Of course, as a self-employed fellow, you might want to claim deductions to lower your tax burden. However, the consequences will be crystal clear when you need a can and are asking for financing.
While claiming deductions isn’t a problem, it leaves the lenders wondering whether you can really repay a loan if you already seek too many conclusions. Therefore, if you are planning to seek car financing in the future, consider reducing your claimed deductions.
Additionally, having a bad credit score lowers your chances of getting an auto loan, especially when you are self-employed or a contract worker. A poor score means that you have had issues repaying loans in the past. Thus, making your potential lenders doubt whether you will be able to repay the dealership loan. The good news is that you can start boosting your credit score now if you want to get a car loan in the future.
Getting a loan with subprime lenders
If you are self-employed and have a bad credit score, the only option left is seeking a car loan. Trying subprime lenders specializing in financing below-average borrowers. Typically, these lenders operate differently from traditional lenders.
For example, instead of focusing on your credit score and history, they will prioritize your income to vet whether you qualify for the dealership loan.
Here are three requirements you must meet to get a car loan with subprime lenders;
- Minimum income amount. Traditional lenders have varied income requirements for their borrowers. However, subprime lenders are strict and require you to have between $1,500 and $2,000 monthly income before taxes, which has to be from one source.
- Payment to income amount. This is established by dividing the auto payment by the pre-tax income. Generally, the ratio should not exceed 15% to 20%, and in case it does, you will not qualify for the loan.
- Debt-to-income ratio. This is calculated by finding the quotient of your monthly bills and the pre-tax income. The balance should not exceed 45% to 50%, and if it does, you will not be eligible for the loan.
How can a contract worker or a self-employed person prove income?
Calculating the ratios above is one thing, and proving your income is another. Therefore, before starting the car purchasing process, have the proof(s) of income ready.
Here is what a self-employed person needs to prepare a proof of income;
- Play right with tax deductions. The unemployed and self-employed can benefit from tax deductions and leverage the burden. However, besides reducing your income, the deductions lower your debt-to-income ratio. Therefore, go slow on the assumptions.
- Have copies of filed tax returns ready. Even if you don’t have a steady income, you can prove income by filing tax returns. The lenders will request copies of proof of filed returns, at least for the last two years.
General hacks for the self-employed and contract workers for getting a car loan
Having discussed enough what matters when applying for an auto loan, here are the tricks for paving a smooth path the self-employed and contract workers can use to increase their chances of getting a car loan;
- Work longer. Whatever you are doing, allow enough time to pass and accumulate some money before applying for a car loan. This verifies your dependability and security, and more lenders will be willing to stand a chance with you.
- Play safe with a reasonable down payment. When you are self-employed and need a car, you will need to pay OK upfront. For instance, people with high credit scores and steady income might need to pay only 10% or 20% of the loan as a down payment. Still, the self-employed will have to beat that margin to qualify for an auto loan.
- Boost your credit score. If you have been defaulting and have not been regular in repaying your credits, start working things right. Although it might take time before you are where you want, it is worth every effort.
- Go slow on the deductions. Don’t just look at deductions as a way to leverage tax burden, but remember that they affect your critical ratios and reduce them.
The bottom line
Although the self-employed and contract workers can find it tough to qualify for a car loan, they are not a lost course and can be eligible for it. All one needs to do is put a few things in the proper perspective, eventually qualifying for the loan. This article is your informant, and by following its suggestions, you will be eligible for car financing despite being self-employed.
Rose Rosie is a writer for the personal finance website, Joy Wallet, which provides readers with useful information, resources, and tools to help maximize their financial fitness.