For self-employed individuals, securing a mortgage often requires more effort compared to those with straightforward salary declarations. However, with proper planning and expert advice, it is entirely achievable. This is where specialized mortgage and bridging finance brokers come in. These professionals can leverage their expertise to negotiate with lenders and emphasize your financial strengths, helping you obtain the most favorable lending terms. Due to key differences in how self-employed income is defined, declared, and verified, having a broker with in-depth knowledge of the lending market can make a significant difference in navigating these complexities effectively.
Self-employed individuals, including sole traders, partners, contractors, or limited company shareholders, often face a challenge when it comes to taxation and mortgage applications. While minimizing profits can help reduce tax obligations, it may also lower the income that lenders consider for mortgage approval. To address this, it’s essential to explore other sources of income, such as shareholdings and dividends, and carefully plan the timing of your mortgage application to present the highest verifiable income. Contractors may sometimes benefit from a specific calculation method that estimates annual salary based on the value of their current contract.
Self-employed individuals can no longer self-certify their income to demonstrate mortgage affordability. This change means that they must prove their ability to cover mortgage payments using actual, documented income, creating a challenge between reducing tax liabilities and maximizing borrowing capacity. Currently, self-employed mortgages account for just 11% of the overall mortgage market, reflecting the increasing difficulty for self-employed individuals to secure lending. In fact, mortgage approval rates today remain at only about 30% of what they were in 2006, highlighting the stricter criteria faced by self-employed applicants.
Income types
- Salary: Salaries for self-employed individuals, such as those in partnerships or shareholders in limited companies, are taxed through the PAYE system, with tax liabilities settled as the income is earned. This regular, taxable salary is considered straightforward for mortgage affordability checks.
- Bonus: Lenders vary in their approach to bonuses. While some base their calculations on an average of past bonuses over several years, others may consider projected future earnings. Understanding each lender’s policy can be crucial when relying on bonuses as part of your income.
- Dividends: For shareholders, dividends provide an efficient way to receive income without paying national insurance. However, not all lenders include dividends in their affordability assessments, and those that do are usually specialist lenders. Expert advice can help in presenting potential dividend payments, especially since these depend on the company’s overall profitability.
- Director’s Loan: Many directors have access to loans through the company, which can serve as a temporary salary top-up. These loans are often interest-free for nine months and one day after the company’s financial year-end. Directors can draw on these loans throughout the year and typically repay them when the company issues dividends.
- Drawings: Drawings are distinct from salaries even though both may be processed through PAYE. They are considered personal income withdrawn during the tax year. The final amount of drawings is established when the company’s profit and loss statement is prepared.
- Expenses: Reimbursement for expenses is not included in mortgage affordability calculations. Since these payments cover the costs of business-related purchases and services, they are not considered income.
- Employee Benefits: Employee benefits, like expenses, are generally excluded from income calculations for mortgage purposes, as they represent non-cash perks or reimbursements not regarded as income by most lenders.
Calculating affordability
Lenders, including high street banks, specialist lenders, and private banks, assess self-employed mortgage applications using a variety of criteria, each weighing different types of income streams in unique ways. For self-employed individuals, the expertise of a knowledgeable mortgage broker can be crucial. A skilled broker can effectively structure and present your financial situation, ensuring that the right lenders are approached based on your specific circumstances. Their industry experience and understanding of each lender’s policies can significantly impact the likelihood of securing the best possible self-employed mortgage deal.
Lenders typically require self-employed applicants to hold more than 15% equity in a limited company before they consider shareholdings in their affordability calculations. When multiple directors or a partnership structure exists, equity holdings may be diluted, complicating the assessment.
Key options for income assessment:
Net Profit (Averaged Over Multiple Years): For company directors who have prioritized reinvesting in their business while drawing minimal income, some lenders opt to average taxable net profit over several years to calculate affordability. In these cases, presenting an annual figure based on a share of the taxable net profit can often be advantageous.
Net Profit with Salaries Added Back: One of the more balanced approaches is when lenders consider a combination of salary and net profit. By averaging both over a set period, this method avoids reducing income through dividends, offering a more comprehensive reflection of earnings. It tends to be more favorable for those not relying solely on dividend payments.
Salary and Dividends: This straightforward approach uses the total amount of salary and dividend income, which works best when the company’s post-salary profits are paid out as dividends. This method is often simple but requires careful management of when and how dividends are issued.
Choosing the right income calculation method depends on how you have managed your business accounts. If your strategy includes retained earnings or holding profits within the business, certain methods may not work in your favor. For these cases, using averages and focusing on the business’s overall financial health can be more reflective of your financial position.
Key Considerations for Securing a Self-Employed Mortgage
If you’re planning to apply for a self-employed mortgage, it’s essential to present your financial situation effectively. This involves managing your accounts to demonstrate stability and making strategic changes that enhance your borrowing potential.
Maximizing your income and utilizing tax-efficient withdrawals can play a vital role, alongside careful management of expenses to avoid overextending yourself. It’s often worthwhile to periodically reassess your finances, implementing small adjustments that save money in both the short and long term. Presenting well-prepared company accounts, accurate tax returns, and accountant certificates can significantly strengthen your application and appeal to potential lenders.