According to official statistics, nearly a third of India’s workforce is self-employed. Just like regular businesses, even self-employed people aspire to grow their businesses. However, unlike established businesses, self-employed face a lot of challenges when taking a business loan. In this article, we look at the challenges associated with business loans for the self-employed.
Lack of Stable Income
The critical requirements for business loan eligibility are the borrower’s age, income, the health of their business, credit score, etc. Unlike salaried people, who have a stable income, self-employed often have to deal with uncertain cash flows. Even if their annual income may be higher than salaried staff, self-employed people have to deal with seasonality. For example, chartered accountants may earn more during tax filing seasons than regular months.
Self-employed people can deal with this challenge by maintaining a healthy business credit score. Here are some ways you can overcome a key hurdle in business loan eligibility:
- Keep your credit utilization ratio at 25%. It means if your credit card limit is Rs. 1 lac, ensure you do not use more than Rs. 25,000 per month.
- Be regular in making your payments, such as credit card dues and mortgage EMIs.
- Keep checking your business credit reports regularly. If there are any errors, take immediate corrective steps.
- Keep business finances separate from personal finances.
If you have other costs, ensure your profitability is healthy. Lenders will not only look at your revenues but also at your profitability. If you are generating a lot of cash, but your profitability is weak, that is a worrying sign for lenders.
Lack of Adequate Cash Reserves
Cash reserves give lenders the assurance about a borrower’s repaying ability even if their income is unstable. Typically, it takes a while before self-employed businesses can have some cash balance. First off, it takes time to acquire a regular set of customers. Then it takes time to maintain the customers and add new ones while maintaining a healthy profit margin. So, while self-employed businesses may become self-sustaining, they may not have adequate cash balances.
To overcome this challenge, keep your costs in check and maintain a healthy balance in your business account. Also, as a best practice, do not apply for a business loan during the first 2-3 years of self-employment. It will give you enough time to settle any existing debts and improve your credit score.
Lack of Growth in Earnings
Lenders prefer lending to businesses with an upward trend in their turnover. Understandably, it takes a while to build a business and then grow it. However, you should avoid taking a business loan until your business is seeing a consistent upward trend. Always keep an eye on your monthly and yearly revenues and put effort into growing your business. Try to acquire new clients while maintaining your existing client portfolio. Also, ensure your rates and service charges are not too low. Timely increases in your rates can also grow your revenues and profits.
In a nutshell, lenders want to be sure about their borrowers’ creditworthiness and ability to repay the loan and fulfil the interest obligations. For salaried people, a stable salary gives lenders confidence about their repayment ability. However, self-employed people should not despair. By maintaining a good credit score and adequate cash reserves, the self-employed can overcome the challenges faced when taking a business loan. The tips mentioned above can also help you in getting competitive business loan interest rates.