If you’re a self-employed entrepreneur, getting additional financing is extremely difficult since the formal lending sector gives limited options. Fortunately, sole trader loans are available to fill the gap and widen your selection.

To better appreciate what sole trader loans can do for you (and prepare yourself should you need one in the future), let’s go through the challenges of getting financial assistance from traditional lenders and things to consider when applying for sole trader loans.

Why is it hard for sole traders to get a loan?

Sole traders often struggle with obtaining a business loan for the following common reasons:

Perception as high-risk borrowers

Sole traders usually generate less revenue than corporations and other more established enterprises. 

They are not recognised as separate legal entities, and their assets are under personal ownership. 

However, this means that the business’ liabilities are also that of the sole traders. If the company fails with unpaid debts, they will lose their income and pay the amount owed from their assets, even if it’s unrelated to the enterprise.

Because of this, many lenders see sole traders as high-risk borrowers and hesitate to approve their loan applications.

These lenders, especially traditional ones such as banks, find transaction data from bank statements insufficient to prove the sole traders’ ability to pay and, therefore, refuse to lend them money.

Extensive documentary requirements

Because of the sole traders’ high-risk business profile, formal lending institutions often require heaps of paperwork and documents for them to submit and qualify for an application.

However, since sole proprietorship business structures differ from established enterprises, sole traders find the requirements tedious and unapplicable to them.

The problem is that traditional lenders, especially banks, don’t distinguish between loans for limited companies and sole traders.

These lenders expect sole traders to be capable of presenting an extensive set of financial statements before considering their application.

They can even scrutinize sole traders’ business monetary conditions to the detail and look for any little reason to deny them their lending services.

Plus, with conventional lending, the waiting and response time often takes weeks, only to end with the rejection of sole traders’ loan applications.

High-interest charges

Another reason sole traders find it difficult to get loans from traditional lenders relates to their perceived high-risk profile.

Conventional lenders usually charge sole traders with high interest rates to compensate for the increased risk of financing.

If sole traders get credit card loans, their interest rates can be compounding and come with additional charges that can quickly pile up if sole traders don’t pay the balance every month.

With these disadvantages and challenges from formal financing mechanisms from banks, self-employed entrepreneurs can turn to sole trader loans as more feasible alternatives.

What are sole trader loans?

Sole trader loans are financing instruments tailored to self-employed individuals building and running their businesses.

Sole trader loans are designed to support these sole proprietors struggling to have their loan applications approved or accepted by conventional lending entities.

How do sole trader loans work?

Sole trader loans work similarly with any other type of loan. Lenders will assess their financial situation to see how realistically they can afford to pay back the borrowed money.

Sole traders still need to present their business’ financial documents, but they’re likely not going to be as comprehensive or restrictive as conventional lenders’ requirements.

These self-employed borrowers can eventually pay the loan back with more affordable interest rates in monthly installments over a set period (usually a few years).

Things to consider about sole trader loans

Sole trader loans are advantageous because they are flexible and can work as cash injections to fund various business expenses.

Here are some things to consider when planning to get sole trader loans:

Type of loan

Many lending entities now offer different types of dedicated sole trader loans suited to self-employed business owners’ current financial situation.

These traders can get term loans (often divided into secured and unsecured), asset finance, business overdrafts, business credit cards, personal loans, and more.

Application process

Depending on the trusted lending entity, sole traders only typically need to fill out an online application form and get results (and the loan amount when approved) in a short period (within hours to a day).

What if sole traders have a bad credit history?

If the applicants have a bad credit history, they can still avail of specific loan types and arrangements.

Although providers will likely consider them high-risk borrowers, they can mitigate this by requiring sole traders to have guarantors, so applicants need to prepare ahead.

What lenders seek to qualify sole traders for loans

When deciding about giving sole trader loans, providers generally look for the same qualities as other entities. These are:

• Character. Providers look at money-related factors, e.g., savings, financial history, loan repayments, years in business operation, and credit score. They also evaluate your ability to save and repay debts promptly, cash flow, income stability, including any bankruptcies, defaults, and lawsuits.

• Capacity. This refers particularly to sole traders’ ability to repay, involving living expenses, income, existing debts, and the number of dependents. Business owners need to ponder on their revenue stability, the amount of money they can raise, and backup plans should their enterprise’s financial state decline. (A practical consideration and example is the current pandemic and what happens when entrepreneurs can’t repay their COVID-19 recovery loan schemes.)

• Collateral involves assets sole traders have to secure their loans in case of defaults. Examples are land, commercial or residential properties, vehicles, and other personal belongings. This usually applies to secured loans where providers review the suitability of these possessions. Before applying, business owners should check first their assets’ condition, value, and liquidity.

• Conditions are set by the lender. This factor includes interest rates, repayment schedules, outcomes for non-compliance, and other requirements or provisions before granting loans and within the debt’s lifespan.

• Capital. Providers assess the applicant’s overall financial standing, including the nature of the liabilities and asset types and liquidity, especially if business circumstances change.

Find the best sole trader loan for your business.

When applying for sole trader loans, it would be best to be honest about your needs and situation to find the best scheme for your business. 

Keep in mind also that several lending institutions are still willing to help you out if formal lenders are reluctant about approving your application.

To learn more about sole trader loans, feel free to check out our rich resource base for informational guides and comparisons.