Self employed home loan

How to get a mortgage while self employed

Applying for a home loan when you are running your own business is completely different to getting a loan while you are employed. The way that they assess your income can be very complicated & is often very conservative.

As a result business owners have a hard time getting a mortgage using their tax returns and financials as evidence of their income. How is it you can get approved without resorting to a low doc loan?

What every self employed borrower needs to know

What the banks don’t tell you is that every lender assesses your income in a different way! Financial statements & tax returns are, to a certain extent, open to interpretation. The credit departments of each lender have come up with their own method of calculating your assessable income.

In addition to this bank staff tend to know very little about how being self employed actually works, after all they are all on a regular salary. The vast majority of them cannot read tax returns or financial statements properly or try to palm off self employed loans to business banking so that they don’t have to handle the complex paperwork.

The trick to getting approved is to apply with the right lender! Our mortgage brokers are all self employed themselves, and have a background working for a lender in a role where they decide if applications are approved or declined. Because of this they can quickly work out the lender that will assess your income in the most accurate & reasonable way. Please enquire online to discuss your situation with one of our brokers.

How do banks calculate your income?

Each lender have their own way of calculating your income. As a general rule there are three main ways they can calculate your assessable income:

• Averaging two years income: This is the main method used by most lenders. Lenders that use this method also look for the percentage change between the two years. If your income increases by more than 20% then they will use the previous years income plus 20% instead of the average. Unfortunately it isn’t accurate if you have had a bad year or if you have only recently started your business.
• Using your most recent years income: We believe this is the most accurate method of assessing a self employed person’s income. Only a couple of lenders use this method.
• Using the lowest income from your two most recent years: This method is used by most lenders when the most recent years income is lower than the previous years income. They assume the downward trend will continue and so use the lowest figure in their assessment of your loan.

The figure that banks use in the above calculation to work out your assessable income is your personal taxable income. However there are some final tweaks that lenders use to calculate your income. These tweaks are known as “add backs”.

What is an “add back”

Your taxable income alone isn’t the same as your actual income that you could use to pay your commitments, including the repayments for the new mortgage. So lenders add back any expenses that you have incurred that reduced your taxable income, however are not a “real” expense or ongoing commitment.

Some examples of add backs are:

• Depreciation: Depreciation is a tax deduction however is not a day to day expense. For this reason some lenders add it back to your taxable income.
• Additional superannuation: If you have made lump sum contributions to super in excess of your minimum requirements then these can be added back.
• Net Profit Before Tax (NPBT): If you have profits that you have retained in your company then these can be taken into account as well. If you don’t own the entire company then lenders will assess your share of the net profit.
• One off expenses: If you had an extraordinary expense then we can often add this back. We may need an accountant letter to confirm this.
• Interest expenses: If you have a business loan or investment loan then it is likely that you have tax deducted the interest that you have paid. We can add this back as lenders will assess all commitments that you have separately in their serviceability calculator.
• Rental property expenses: Depreciation on your properties, management fees, repairs and other rental property deductions such as negative gearing are all added back. Rent income is also deducted from your income as lenders assess this separately to your main income.
• Company car: If you have a car that is used by your business and yourself then it is likely that you have tax deducted many of the expenses associated with this car. Lenders do not add this back, however they often will add in an extra $3,000 to $6,000 in income to compensate for this.
• Trust distributions: If you have your business in a discretionary trust and have chosen to distribute income to some of your family members then in most cases this can be added back. Note that many lenders do not accept this add back, or will only do so if you provide a letter from your accountant to confirm that the beneficiaries are not financially dependent on this income.

As you can see this can get quite complicated! As a result many bank employees make mistakes when assessing your income.

What mistakes do banks often make?

We often see mistakes in the way that the banks calculate the income for self employed borrowers. For complex loans we make extensive notes and if need be call the assessor and walk them through the financials to ensure they assess the loan correctly. The most common mistakes we see are:

• Lack of understanding: Complex trust structures with multiple companies and trusts are often handled by bank staff that lack the experience to understand what is actually happening with your income. In these cases we would talk to your accountant and then talk to the assessor to ensure they understand exactly what is going on.
• Double dipping: This is where the lender takes an income into account twice (e.g. Net Profit Before Tax and also accepting the dividend paid to a director) or takes an expense into account twice (e.g. forgetting to add back interest on loans).
• Company car: Lenders regularly ignore the benefit a self employed person receives from tax deducting their car expenses in their company. We always draw their attention to this in our notes.
• Procrastination: Technically this is not an error as it is done on purpose! If your loan is particularly complicated then we find that bank staff may take their time to get to your application. We usually speak to management and ask them to assign your loan to an experienced assessor who will enjoy the challenge of a complicated application.

How recent are your tax returns?

By March or April each year most lenders begin to ask for tax returns for the most recently completed financial year. Up until that point you can provide the tax returns from the year before! So for example if you applied in January 2010 most lenders would require your tax returns for 2007 & 2008, however in March 2010 most lenders would require 2008 & 2009.

Of course there are always exceptions! One of our lenders can accept older tax returns as an exception to their normal policy. This is useful for people who haven’t had a chance to lodge their most recent return. One of our other lenders only requires one years tax returns. This is useful for people who have had a bad year the year before or who only recently started their business.

The secret to getting approved

Too many self employed people go directly to their bank when applying for a loan. Did you know that each lenders policy is very specific as to how a self employed person’s income is calculated? As a result of this many self employed home loan applications get declined, simply because they apply with the wrong lender.

We help our customers to apply with the right lender, one that will understand their financials and assess them in the best possible light. In particular we will also make notes to ensure that all of the great work your accountant has done to reduce your taxable income doesn’t stop you from borrowing money! Please enquire online to discuss your situation with one of our mortgage brokers.

Low doc loans for the self employed

If you cannot prove your income using traditional methods, such as by providing tax returns, then a low doc home loan may be the answer. We’ve created a page specifically to help people who may need a low doc home loan.

Apply for a home loan

Our mortgage brokers have the experience required to handle complex self employed home loan applications. Please enquire online to discuss your situation with one of our mortgage brokers.