Any lender before approving any category of loan checks if the borrower has the capacity to repay the loan. This is the thumb rule of any financial or Non-Banking Financial Institution (NBFC) and in most cases, the loan granted by a lender is 5 – 6 times higher than the income of the borrower. However, the amount granted to the borrower depends on the nature of his income, sources of income and the bandwidth of his income.
In a lot of cases, financial units or banks prefer self-employed people over salaried people for loans and there a lot of unsaid factors that they keep in mind while doing so. Let us talk about those factors at length:
Income in Cash
A salaried person’s income is documented by the employer which means the tax calculation and other deductions are in record. The same does not apply to a self-employed person as the tax he pays and other deductions are under his control and at his disposition. In simple words, a self-employed person has the flexibility to manage his cash transactions without recording it in any accounting books. The surplus, untaxed cash is taken into consideration by the lenders and they do a rough calculation of the extra income and accordingly sanction loans.
Actual Expenses versus Estimated Expense
Self-employed professionals like doctors, lawyers and chartered accountants inflate their expenses and even include their personal expenses in their account books to show losses. This is a common practice and even the tax officials are aware of it. Ideally, a person cannot include their personal expenses in their account books and if they come under the scanner of tax officials they will be penalized heavily. So, when acquiring a loan people present their net income but lenders always estimate a higher amount and assume that to be their annual income. Based on the estimated amount, they decide on the eligibility and amount of the loan which is marginally higher than that of a salaried person.
Running a business has its own set of expenses, be it investing in machinery or just buying office supplies, these investments are very much a part of your cumulative business expense. These expenses can be added to your regular account books and even the tax department takes this into account. The amount spent on the business for its sustainability is not exactly an outflow of the cash but this is also taken into consideration while checking the eligibility of a person. Having a record of every detailed expense, gives the financial institution a better idea on the inflow and outflow of the cash and how able the borrower is for a given amount of loan.
Duration of Earning
The compulsory retirement age of a salaried person is 58 or 60 but no such rules apply for a business owner. A person who has his own establishment can continue to work for as long as he wants. The working tenure of a person also is a determining factor for the duration of the loan. This works in the favour of a businessman as banks generally offer such people a longer payback period for loans as compared to a salaried person. A working person is expected to clear their loan before they are slated to retire.
There is still a certain degree of risk involved in giving loan to self-employed person but financial institutes or banks, will never hesitate to give loan to a person who has good credit history and is successful in their venture.
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You can also read about benefits of business loan.
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