6 Ways Being Self-Employed Can Impact Your Credit (& What to Do About It)

Woman putting out an open sign on her business

It’s ironic that in a country that celebrates independence and the entrepreneurial spirit, life can be pretty hard when you’re self-employed. Taxes are more complicated. Health insurance is expensive and difficult to navigate. Even at-work injuries and gaps in income usually covered by government programs are out of reach.

Credit is one of the farthest-reaching categories. Lenders prefer W-2 income to self-employed earnings, even when an entrepreneur is making more each month. Here are six specific ways being self-employed can create roadblocks for your financial goals, with insights on how you can overcome those roadblocks.

1. It Can Be Difficult to Get a Low Interest Rate

You might be approved for a loan, maybe even with no more hassle than somebody with a regular job. The trouble is when you look at your statement and see how much that loan costs.

Your credit is all about risk from a lender’s perspective, and banks consider the self-employed a higher risk than people with a regular job. You’ll pay more interest on a similar loan than you would with employment earnings. As a result, every borrowed dollar costs you more — sometimes much more.

The Solution

You have two ways to mitigate this issue. First, look at the fine print on every loan you’re offered. Find the nominal APR (annual percentage rate) and the actual price you’ll pay after fees and escalators. Don’t be shy about negotiating if that price is high.

Second, form a meaningful relationship with the bank where you hold your business accounts. Know the manager’s name, and say hi to the tellers. When it comes time to negotiate for credit, this can grease the wheels.

2. Inconsistent Paychecks Can Lead to Missed Payments

You gave up a lot of things you didn’t like when you went to work for yourself, but one generally positive perks you let go of was predictable paychecks showing up on anticipated days. When you’re self-employed, your income ebbs and flows each month. It may be enough to get by, but it’s hard to set a budget with that kind of cash flow.

When business lags, it can get so low you have trouble paying all your bills. Missed and late payments go on your credit report, making it harder to get credit during the next slow patch — which means you have even more trouble paying your bills. This downward spiral can severely damage your credit and your business’s health.

The Solution

You can solve this quickly by changing your relationship with your budget. Set a salary and pay it as W-2 income to yourself or take an owner’s draw. Base your monthly budget, including debt payments, on that amount. Any extra money you earn becomes a bonus once a month or once a quarter, which you can use for large purchases or fun indulgences. It takes a little organization upfront but is well worth the trouble.

3. Lenders May Need a Ton of Additional Documentation

When you’re looking for a loan as an employee, you just show a couple of pay stubs and tell the lender how to contact your boss to confirm that you work there. As a self-employed person, this process gets replaced by a much more in-depth look into your financial situation.

Your credit score won’t be enough proof that you’re a low-risk borrower. Lenders might ask for additional documentation such as a profit and loss statement, business plan, several years of company and personal tax statements, and even letters from vendors or your landlord. The process is more complicated and requires meticulous record-keeping.

The Solution

Keep all of your records. Keep them up to date. Keep them well-organized and easy to find, both in hard copy and electronic format. If you already do this, the keep doing it. If you don’t do it, you’re in for some work.

Get a list of the documents lenders are most likely to want when you apply for credit. Over the next several weeks, locate the materials you have and create the documents you don’t have. Make them look sharp, and store them someplace where you can find them easily.

4. You May Be Targeted By Predatory Lenders

Predatory lenders love business loans. Regulations are more relaxed than those for personal credit, and the numbers can be much higher. You may have already received calls from them, offering you a high credit limit with unreasonably low requirements and stipulations. They’re more like loan sharks than traditional lenders.

These loans tend to take advantage of desperate or inexperienced business owners, trapping them in a cycle of minimum payments and high interest. Usually, they come with one or more deal-breaking aspects, such as:

  • Exceptionally high interest rates (often more than 20%)
  • Hidden costs and fees spiking the effective interest rate to levels that would otherwise be illegal
  • A contract allowing the lender to debit payments from your account at will

Such conditions make for bad loans and can kill a business over time. Even if you make the payments faithful, these lenders often report late payments early and negotiate in bad faith. They can ruin your credit quickly, especially if you start to push back against their questionable policies.

The Solution

Apply two simple rules to any credit offer you’re considering. First, if the lender called you rather than the other way around, you should be cautious. Second, apply the well-worn advice that anything that seems too good to be true probably is, and move on.

5. You May Lean on Personal Credit to Finance Business Expenses

Because business credit is expensive and hard to get, many self-employed people end up putting business expenses on personal credit cards. Credit churn happens when you’re constantly using a personal card to cover operational costs, including inventory, payments to vendors, and similar expenses, and then quickly paying that personal debt with business income.

This one’s not so much a problem as an opportunity with a downside. The churn puts you at risk of carrying a balance every month. When business revenues drop, that balance can harm your credit history by showing you’re borrowing more than you should. It also increases your business costs because you’re paying interest on those expenses.

The Solution

As we said, it’s also an opportunity. As Tim Ferriss says in The 4-Hour Workweek, you can run those expenses through a card that earns cash back, air miles, or other rewards. As long as you keep your balances paid each month, the churn can net you meaningful savings, tax-free.

6. Your Reported Taxable Income May Be Too Low for Credit Applications

One benefit of being self-employed is charging some expenses to your business. Although you should never be abusive or dishonest, it’s common practice to drive a company car, expense office supplies, and apply part of your utilities and phone expenses to your business. These write-offs save on taxes but can cause credit issues.

For most self-employed people, the income they report on their tax returns doesn’t represent the buying power of their full earnings each year. This can be a problem when you’re trying to get credit and the lender wants to compare your reported income against the needs of the loan you want.

The Solution

Unfortunately, there isn’t a reliable solution to this dilemma. If you report more income, you pay more taxes. If you report less income, your access to credit may suffer. Your best bet is to plan for your credit needs to the best of your ability. That way, you can at least adjust your tax strategy accordingly.

Follow credit best practices no matter what your employment status is

For anyone, self-employed or not, it pays to keep your credit score as high as possible and your credit report clean. But this is especially crucial for the self-employed. A high enough credit score can overcome or alleviate most of the problems mentioned above. Keep yours healthy and robust with techniques like:

  • Checking your credit report regularly for problems
  • Paying your credit card balances down to zero whenever possible
  • Paying all bills on time
  • Negotiating directly with lenders if you can’t avoid paying late
  • Avoiding unnecessary applications for credit
  • Keeping zero-balance cards open and on hand, even if you don’t use them

There’s no guarantee that getting all the credit you need will be a cinch, even if you're armed with a good credit score and reliable business records. But it’ll certainly be easier if you follow these tips and keep your credit healthy on a day-to-day basis.

Tagged in Loans, Taxes, Earning extra income

David Roame is self-employed as a freelance writer in Seattle, and his area of expertise is personal finance.
  • Better Business Bureau A+ rating Better Business Bureau
    MMI is proud to have achieved an A+ rating from the Better Business Bureau (BBB), a nonprofit organization focused on promoting and improving marketplace trust. The BBB investigates charges of fraud against both consumers and businesses, sets standards for truthfulness in advertising, and evaluates the trustworthiness of businesses and charities, providing a score from A+ (highest) to F (lowest).
  • Financial Counseling Association of America Financial Counseling Association of America
    MMI is a proud member of the Financial Counseling Association of America (FCAA), a national association representing financial counseling companies that provide consumer credit counseling, housing counseling, student loan counseling, bankruptcy counseling, debt management, and various financial education services.
  • Trustpilot Trustpilot
    MMI is rated as “Excellent” (4.9/5) by reviewers on Trustpilot, a global, online consumer review platform dedicated to openness and transparency. Since 2007, Trustpilot has received over 116 million customer reviews for nearly 500,000 different websites and businesses. See what others are saying about the work we do.
  • Department of Housing and Urban Development - Equal Housing Opportunity Department of Housing and Urban Development
    MMI is certified by the U.S. Department of Housing and Urban Development (HUD) to provide consumer housing counseling. The mission of HUD is to create strong, sustainable, inclusive communities and quality affordable homes for all. HUD provides support services directly and through approved, local agencies like MMI.
  • Council on Accreditation Council On Accreditation
    MMI is proudly accredited by the Council on Accreditation (COA), an international, independent, nonprofit, human service accrediting organization. COA’s thorough, peer-reviewed accreditation process is designed to ensure that organizations like MMI are providing the highest standard of service and support for clients and employees alike.
  • National Foundation for Credit Counseling National Foundation for Credit Counseling
    MMI is a longstanding member of the National Foundation for Credit Counseling® (NFCC®), the nation’s largest nonprofit financial counseling organization. Founded in 1951, the NFCC’s mission is to promote financially responsible behavior and help member organizations like MMI deliver the highest-quality financial education and counseling services.