There are enough stories in the press these days around the difficulties of obtaining a mortgage for those who are self-employed, but there does seem to be a growing trend amongst lenders that they are at least trying harder to understand this sector of the market.
Coreco’s Rob Gill takes a further look at the question.
Part of the issue is that Self-Employment can take many forms; whether it be a Contractor, Freelancer, Consultant, or any other small business providing all manner of goods and services. Whatever form they may take, many end up structured as a limited company, which is, of course, a separate legal entity in their own right.
It is this legal status that presents the first challenge when the owners of a limited company seek to obtain a mortgage.
The first point to consider is how do lenders define the term “owner”? Quite simply, the vast majority of lenders will define anyone who owns 20% or more of the business they draw their income from as self-employed. Whether an individual is technically employed by the business and therefore receives PAYE income and payslips like any employee of a larger company, is immaterial if they own 20% or more of the company that employs them.
This 20% level is considered the point at which an individual has a significant influence on the running of the company. A lender will, therefore, look at the experience of that individual in running the current (or similar) business, and typically they will want at least a 2-3 year track record in the applicant’s chosen field.
Lenders will often take an average of the last 2-3 years income figures for the self-employed, which may make life difficult for new businesses where the initial years may not be all that profitable, or where profit has fluctuated due to market conditions or investment.
In the right circumstances, however, certain lenders will consider applications based on just one year’s, most recent accounts, either because the business is newly established or profits have fluctuated.
One more point to bear in mind is how lenders define income from a limited company. Because they are legal entities in their own right, many lenders will only take personal income drawn from the company by the individual owners, in the form of salary and dividends. They will not, therefore, include any retained profits as these profits are deemed owned by the c0mpany until they are taken out by the individual owners. This can be a huge disadvantage for business owners seeking to retain profits within a business.
For borrowers such as this, it is important to identify and approach the handful of lenders who are happy to consider the share of net profit, retained or otherwise, as income figures.
All of this presents a potential minefield to the self-employed and business owners when it comes to finding any mortgage, let alone the most suitable one for them. Bad advice can lead to borrowers being “squeezed” into the wrong mortgage product, paying a higher rate than necessary or restructuring their income to accommodate the demands of a less flexible lender.
It is therefore imperative to search for the right mortgage adviser, one with experience with self-employed clients, who understand basic company structures and accounts and who has relationships with the right lenders and underwriters.
They can not only help you to avoid these pitfalls but can also be an invaluable guide throughout every stage of the mortgage process.
Gemma and Paul approached Coreco seeking a mortgage of £700k to buy a new family home in North London.
Paul was a self-employed consultant who had just finished his first full year of trading. He owns the business, a limited company, 50-50 with Gemma. Previously he was employed as a consultant in the same industry. His first year of trading had proved so successful he was able to leave a substantial amount of profit within the business, drawing less than half of the net profits in the form of salary and dividends.
With just one year’s trading history and accounts, Gemma and Paul were facing substantial difficulty obtaining the required mortgage. Paul had also been advised that he must draw a far greater proportion of the net profit as income so that it would show in his tax return and therefore could be taken as income by one possible lender.
We were able to find a highly competitive mortgage for the client based on just one year’s accounts, and using the net profit figure for income rather than drawings. This allowed Paul to keep his profit retained within the business, saving him a potential personal tax bill of several thousand pounds.