Self-Employed Mortgage – How Does it Work?

When you are self-employed, you may wonder how much you can borrow when taking out a mortgage. The nature of being self-employed often means that your income is not fixed each month/year. Without the security of a contract of employment, you may find it difficult to persuade some lenders that your income is stable enough to allow them to approve you for the mortgage that you want.

Sure, assessing the mortgage affordability for a self-employed person can be a little more difficult than for an employed person, but it’s by no means uncommon. Many lenders are well-versed in helping self-employed applicants get the right mortgage.

How will I be assessed by a mortgage lender?

All lenders want to see is that you have a steady, reliable income to prove that you will be able to meet the monthly mortgage commitment that you are looking to take on. It is important to try and present the evidence to support this. If you have been self-employed for a number of years, then you should be able to produce prepared financial statements that show that you’re able to generate a reliable income. This is usually in the form of accounts, annual tax returns, and bank statements.

If you are newly self-employed, it may be more difficult to prove your earnings and provide a big enough picture of your finances. Having only one year of accounts is a common problem for a self-employed person applying for a mortgage, as many lenders require two or three years’ worth. Lenders base mortgage assessments around risk, and the longer you’ve been trading for should in theory make your application stronger. With this in mind, you may also have some difficulty if you have had a big increase in your income or uneven income over the last few years. In these cases, lenders may average out the last two or three years to calculate your affordability or ask you to provide proof of your future income. This could include new clients or contracts, or a significant amount of savings.

If your business is quite young or expanding, then it might be that your income has shown a big increase over recent years as profits have increased with your success. Lenders will generally average out the last few year’s income, meaning you may not be able to borrow quite as much as you might based on your last year’s figures.

And of course, accounts are produced several months after the year-end, so won’t necessarily reflect the current year’s performance. In these cases, it might help to show evidence of contracts secured by your business to prove that a higher income is now sustainable. Financial projections of income based on secured contracts might also help persuade lenders of future earnings. Ideally, these should be prepared and supported by a qualified Accountant.

Generally, the more years of accounts you can provide, the better placed you’ll be to get the right mortgage for you. Lenders will be on the look-out for consistent or increasing profit over a number of years, as they will normally assess you via your net profits, rather than your turnover.

Types of self-employed applicants

As a self-employed person, you’ll typically fall into one of four categories; a Sole Trader, a Partnership, a Limited Company, or a Limited Liability Partnership. Limited Companies and Limited Liability Partnerships are generally treated the same way for income assessment purposes.

Let’s take a look at how they differ:

• Sole Trader – as a Sole Trader, your profit generated at the end of each year is your annual income and is declared on your annual tax return. Your tax return will provide evidence of this but this will need to be accompanied by a tax overview.
• Partnership – as a partner in a partnership, you make drawings from the profit generated by the partnership in accordance with your partnership share. A three-partner firm might split it’s profit three ways, so a third each. Again, this income must be declared each year on your personal tax return and is taxed accordingly. If the partners decide not to fully draw all the profit they have generated and instead leave some cash in the business, you may be able to claim your share of the undrawn profit as additional income – it depends on the lender. You may also need to show tax returns and partnership accounts to show annual income.
• Limited Company & Limited Liability Partnerships – as the director and/or shareholder of a registered company, you have a few more options on how you might take your income. For tax reasons, it is often advised to pay yourself a minimum annual salary equivalent to your individual personal tax allowance and then take an additional salary in dividends. It’s quite common for company directors to leave in the profits from the business, known as retained profit. This can also be used to assess affordability. When making an assessment of income, there are a few different options that will give a variety of outcomes, so it’s important to speak to an experienced mortgage advisor, such as us here at Mortgage Light, and we will guide you through this before submitting a mortgage application.

What documentation do I need to provide?

When self-employed, you may need to provide a substantial amount of evidence to show how your business is faring and to shed light on your financial situation. It’s a good idea to have the following to hand:

• A minimum of 2-3 years of accounts for your business (ideally) prepared and signed off by a Chartered Accountant (although we do have lenders that consider one years worth)
• Your last 2-3 years personal tax returns (ideally 3 years SA302s and a tax overview from HMRC)
• Last 3 months personal and business bank statements
• Photographic ID with your current address on it, such as your driving license
• Proof of address (council tax, utility bill, or financial statement)

You may also be required to provide a statement showing your deposit funds and/or any evidence of life insurance you have in place to cover the mortgage.

How can I give myself the best chance of getting approved for a mortgage?

Assessing a self-employed person’s income can be a difficult and subjective thing. To give yourself the best chance of securing the mortgage you need, there are a few things that you can do to prepare. Firstly, it’s a good idea to speak to us here at Mortgage Light at an early stage. We’ll review your options and to identify the information you’ll need to collect in order to have the strongest application. We know that not all lenders have the same criteria, so we can help to match you with the most suitable lender and let you know what they will need in order to assess your affordability.

When applying for a mortgage – whether you’re employed or self-employed – having your accounts in order and up to date is important. Perhaps ask an accountant to prepare your accounts if possible. Many mortgage lenders want self-employed mortgage applicants to provide business accounts that have been drawn up or approved by a chartered accountant. Make sure that everything is paid on time where possible, adhere to the conditions that you’ve agreed to, and close any credit accounts that you no longer use.

It is also a good idea to take a look at your credit score using a website such as Clear Score. Check that there aren’t any adverse entries against you, and if there’s any that you think might be incorrect then contact the relevant company and ask for them to be corrected.

It’s also a good idea to make sure that you are on the electoral roll. Lenders use information from the electoral roll to confirm things like your name, address, and residential history. They need to check that the information about you is up to date before they think about offering you a mortgage or loan. With most lenders, it will actually hurt your credit score if they can’t find your details. Some might even choose to simply refuse the application if they can’t find you at the residential address that you’ve given.

In conclusion, there is no black or white answer for how much you can borrow for a mortgage when you are self-employed. Lenders will look at many different factors when assessing you; your net profits, your lifestyle spending, your financial commitments, and any dependents.

To get a personalised calculation of how much you can borrow, it’s always best to speak to a mortgage advisor. Contact us at Mortgage Light and speak to one of our experts. We are here to help you take the next step.