Understanding the calculation of income for self-employed mortgage applications
There is a big difference between mortgage lenders assessment of income for self-employed applicants and those who are employed and paid on a PAYE basis.
This short guide explains how lenders typically calculate income and some of the pitfalls to be aware of when becoming self-employed.
Lenders usually class you as self-employed if you are a sole trader, in a partnership, or when you own more than a set percentage of a limited company (typically 25%).
Employees paid a PAYE salary who own a significant share of another company would have two incomes, one from employment and one from self-employment.
If classified as self-employed, most lenders require a minimum of two years of full accounts before lending; only a limited number may lend based on a single year.
There are certain exceptions, for example, where an applicant buys a share of a limited company that is a ‘going concern’.
If you are considering starting these types of employment, securing a new mortgage deal before switching to self-employment could be a good idea.
When classed as self-employed, the lender will base their affordability assessment on your pre-tax net profit, not your turnover.
That is essentially your money received minus all allowable deductions, typically the profits stated in your tax returns.
If you own or are a major shareholder of a limited company, you typically pay yourself a minimum PAYE income and dividends; the two added together would be considered your profit.
It is important to remember that leaving profit within the business as capital rather than drawing these funds as dividend income will limit the maximum borrowing potential available to you with most lenders. But we can help you arrange loans with lenders that consider this additional profit.
It may be worth taking a ‘tax hit’ in the accounting year before arranging a mortgage if the previous year’s drawings were low, as many lenders will refuse to look deeper into your accounts, basing their assessment on just your PAYE and dividend and ignoring excess profits.
If your profits or drawings have decreased, most lenders will work on the most recent year’s accounts; if increasing an average of two or three years is typical.
Proof of income for the self-employed usually comprises either your SA302 or self-assessment tax computations, or a copy of your company accounts for the last two to three years. Some lenders will request accountants’ certificates if these are not available.
For the sole traders or those submitting their tax returns it usually pays to keep your SA302s handy for coming mortgage applications, although you can request reprints from HMRC, or easily download these from HMRC online if you have access.
For help with your self-employed mortgage, get in touch on 0345 4594490.