Self-employed? How much do you earn for mortgage purposes?

We often find that our self-employed applicants are unsure what to consider as their ‘income’ for mortgage purposes when making a mortgage application.

This is not a simple question. What a self-employed applicant can consider as income will depend on the mortgage lender there using and most importantly their trading style. Other factors include ownership of the business, type and history of trading, and how income is drawn from the business.

To help you get a feel for how things work we outline some main points below.

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Limited company directors

If you are making a mortgage application as a limited company director, this is perhaps the most complex area of all.

Key considerations are:

  • Your shareholding within the business
  • How long the business has been trading
  • How much PAYE you receive
  • How much profit the business generates
  • What you do with that profit (i.e. have dividends been paid)

Shareholding under 25%

If you have a shareholding of under 25% many lenders will consider you as employed for mortgage purposes.

Contractor

Sometimes a limited company is set up purely to support the contracting of your services to another business. In these cases, business accounts and profits are not always relevant as some lenders will underwrite your income based on your day rate.

Typical Contractor calculation – Day Rate X 5 X 46 weeks

Assessing income on a mortgage application for a standard limited company director.

PAYE

Anything you pay yourself under the PAYE scheme will be considered as income by all mortgage lenders.

Please note this does not mean you can simply make yourself some PAYE payments regardless of business profit just to get a mortgage. Lenders expect to see that the business can afford the PAYE and that it has been consistent.

PAYE will be shown on your SA302 as ‘Pay from all employments’.

Dividends

All lenders will consider dividends from a limited company owner provided it is evidenced that the company can afford the dividends paid.
As an example, if a business has built up £100,000 of profit over a period of years, and the business owner decides to take £60,000 in dividend following a year no profit, that would raise alarm bells for the mortgage lender.

Dividends are evidenced for mortgage lenders via your SA302 and are shown on the SA302 as ‘Dividends from UK companies (plus 10% tax credits)’.

Profit

Many limited companies ‘retain profits’, in other words the money left after expenses, PAYE, and Corporation tax, is left within the business.

Some mortgage lenders will consider PAYE plus profit, rather than PAYE plus dividend.

Points to watch

Most lenders, where they consider profit, work on ‘post-tax profit’. Occasionally a lender will work on ‘pre-tax profit’.
Lenders are interested in profit only where the applicant is in control of that profit and can decide whether dividends are paid. Therefore most will ask that the mortgage applicant(s) own the business outright, others will want the applicant(s) to have a majority shareholding, some are comfortable if the applicant(s) own at least 25% of the business.

Track record

You need a track record to raise a mortgage against self-employed earnings. With some lenders that track record has to be a least three years, other lenders will consider you after two years trading.
Lenders will generally average your ‘income’ over two or three years. In these cases, if income has dropped over that period, lenders will work on the lower figure.

One year’s trading

There are a handful of lenders that will consider a self-employed applicant after one year’s trading, which is a useful addition to the options available in the market.

Less than one year’s trading

Obtaining a mortgage when you have just started, just bought, or just bought into a business is not impossible, but can only be achieved in certain specific circumstances – in these cases you should speak to a mortgage broker highly experienced in the self-employed arena.

A and B Shares

We occasionally see cases where a limited company has two styles of share issued classed as ‘A’ and ‘B’ shares. This is a trick sometimes used by Accountants to add some flexibility into the entitlement of shareholders to profit and management. It causes numerous complications with mortgages for a limited company director. If your business runs different share types speak to a mortgage broker every time.

Self-employed as a partnership

A business partner is taxed on their share of the businesses income after business expenses. Therefore it is an easy assessment for a mortgage lender. A business partner’s income is clearly stated on their SA302 (statement of taxable income provided by January 31st each year).

Partnership income is listed on the SA302 as ‘Profit from Partnerships’ and is what the mortgage Lender considers as income.

Limited liability partnership

Members of Limited Liability Partnerships are taxed in the same way as partners in a standard partnership and are therefore considered for mortgage in the same way.

Sole traders

For sole traders the typical area of confusion is when the applicant considers their turnover as their income for mortgages purpose.

Mortgage lenders do not consider turnover as income for mortgage purposes.

A sole trader will have deductible business expenses which are subtracted from turnover to give a net income figure on which income tax is payable each year. It is that figure, which is clearly shown on the SA302 under ‘profit from self-employment’.

This is what the lender considers as income.

Multiple sources of income and styles of trading

We occasionally see applicants there are trading self-employed across more than one business and across more than one trading style.

In these cases each business and trading style is considered on its own merits. The prospective mortgage borrowers should be aware however, that where lenders consider two sources of income, they typically only consider, half the total of the lower of the two incomes.

Change of trading style

Sometimes self-employed mortgage applicants will have changed trading style within the last two or three years. For example a sole trader that has been advised by his or her Accountant to incorporate as a limited company. This can be a problem as the trading history clock is set back to day one and most mortgage lenders will wait for one, two, or three years trading in the new style before considering the applicant.

Fortunately, there are lenders that can manage an applicant who has recently changed trading style. Again, this is an area where you need the help of an experienced independent mortgage broker.

SA302s

SA302s are statements HMRC of your self-assessment account for each tax year. These are now crucial documents for assessing mortgage lending and need to be accompanied with a sister document known as a Tax Year Overview. Your tax year overview is an account of tax due on and paid for each tax year.

More about SA302s and Tax Year Overviews and how to obtain them here

Please note that, a copy of your self-assessment return is not an SA302 and will not assist your mortgage application.

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