A side hustle can be a fantastic way to boost your income, pay down debts and increase your financial security. But gig work, like a side hustle, may also be impacting your credit without you being aware.
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If you’re planning to take out an auto loan or buy a home in the future, you’ll need to understand and prepare for how your gig work could impact that process.
Gig work is naturally unpredictable, and your income fluctuates, not only from month to month, but from year to year. That’s in direct contrast to the predictable incomes that lenders traditionally use to evaluate creditworthiness. Scott Bialek, co-founder of Hurst Lending, explained that when your income constantly changes, it’s difficult for lenders to calculate a debt-to-income ratio, which is one of the main factors they use when evaluating credit applications.
“Underwriters often calculate your qualifying income based on your lowest earning months, rather than your average,” he explained. As a gig worker, your lowest earning months might not accurately reflect your actual income, so you might not qualify for the credit that you apply for. “You need to provide a year-to-date profit and loss statement signed by a CPA to override this assumption.”
“Documentation is the only way to bridge the gap between your reality and their rigid guidelines,” Bialek said. “A signed statement from an accountant carries weight that self-prepared spreadsheets never will.”
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According to Garth Sheriff, president at Sheriff Consulting, artificial intelligence is shaping the underwriting process, and it could make things worse for gig workers. He explained that gig workers must provide much more documentation during the underwriting process than employees, but gig worker applications are still poorly processed. “As underwriting at financial institutions moves further into automation and AI, this will get worse because of a bias to see employees as less risky than gig workers,” he explained. That bias is due to the uncertainty of cash flows that comes with gig work.
Gig workers must be prepared to provide tax returns, credit scores, a list of clients and details for revenue, plus lenders may require additional documentation. Sheriff explained that while a credit score is still key to approval, most lenders also focus on future earnings when assessing the risk of lending to an applicant.
Certain lenders are better suited to evaluate applicants with gig income than others. According to Bialek, online lenders who focus on cash flow often approve applications from freelancers much faster than traditional lenders do. “These modern financial companies review your bank statements to verify revenue instead of demanding W-2 forms,” he explained. “You generally find higher approval odds here because they understand how gig economy payments work.”
Bialek has found that connecting your bank account directly can also help significantly speed up that review and approval process.
Before you apply for credit, Bialek recommended auditing your tax returns from the past two years to verify that your net income looks healthy enough for you to be approved. “Lenders look at your bottom line after deductions, rather than your gross revenue, because they need assurance regarding repayment ability,” he explained.
While many freelancers write off every expense to lower their tax bills, doing so may disqualify them from financing big purchases. Bialek explained that you might need to claim fewer deductions this year, which could increase your adjusted gross income to meet the lender’s debt-to-income requirements. “Showing a profit on paper costs more in taxes now, but secures the loan later,” he said.
Bialek recommended immediately requesting an adverse action notice from a lender if your application is denied. Federal law requires the lender to provide a document explaining why they rejected your application. “Review that notice carefully to spot errors in your credit report or income verification,” he suggested.
Even if you don’t anticipate needing to apply for credit in the near future, you can take steps now to make yourself a more competitive applicant.
Sheriff recommended that gig workers work with a CPA or financial advisor to build a formal business case document. When you apply for credit with any financial institution, you can present that package as part of your application.
This might also be time to reevaluate how you’re deducting expenses on your tax return to lower your tax bill. If you anticipate making a major purchase, such as a home, and your tax deductions significantly lower your income, you could negatively impact your chances of getting approved. Be sure to speak with a tax professional for help specific to your situation, and when possible, plan out large purchases that will require financing several years in advance.
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This article originally appeared on GOBankingRates.com: 3 Ways Your Side Hustle Might Be Hurting Your Credit Without You Knowing It
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