Guide to Self Employed Mortgages

If you are self-employed and looking for a mortgage, there are likely to be a myriad of questions swirling around in your head. From the type of lenders who will accept your income to exactly how your income is used to calculate affordability.

The good news is there is a range of lenders who go out of their way to attract self-employed borrowers and have favourable guidelines. Finding those lenders can be tricky and each one will have different requirements.

Let’s explore further with our complete guide to self-employed mortgages.

How to Get a Mortgage When Self Employed

Obtaining a self-employed mortgage is in theory no different to getting a mortgage when you are employed. The same basic rules will apply whether you are self-employed or not.

The core benchmarks you will need to meet are:

Unfortunately, for self-employed borrowers, there are additional hurdles to overcome, normally to do with income and demonstrating to a lender you earn enough to afford the mortgage.

How Many Years of Self Employment is Needed for a Mortgage?

Most lenders will require multiple years of Tax Calculation and Tax Year Overview documents to evidence your income for self-employment. Tax Returns are no longer accepted as suitable income proof with mortgage lenders.

Typically, lenders will ask for two or more years’ worth of Tax Calculation and Tax Year Overview documents. If income varies greatly over those years, a lender may even request further documentation like business bank statements to try and gauge an accurate average income.

The nature of self-employment does not lend itself to a static or stable income as businesses go through peaks and troughs. One year you might experience extraordinary demand for your services and the next may be quieter.

For a lender, they are concerned about honing in on the annual income that is most realistic to expect year on year. Most lenders will take an average of your income declared on your Tax Calculations over the latest two years. Although, if your income has declined in the latest year compared to the previous, they will take the latest figure as a precaution.

Fortunately, there are a handful of lenders who are much more flexible, taking your latest years’ accounts as your income level. This can be extremely beneficial if your business has grown over the last tax year.

Difference Between Sole Trader, Partnerships, Limited Company Directors for Mortgages

Lenders also treat the various types of self-employment differently. A sole trader for example may be asked to provide different evidence to a Limited Company director. Additionally, lenders will assess the income in different ways depending on the nature of your self-employment.

Sole Traders

Sole traders will need to provide their Tax Calculations and Tax Year Overviews for evidence. A Tax Calculation summarised the income received by an individual following submission of their Tax Return. The corresponding Tax Year Overview shows a summary of the tax payable based on the Tax Calculation information.

If a lender averages out your income, they will add the Tax Calculation figures over multiple years (normally the latest 2 years) and then divide the total by the number of years they are assessing.

Partnerships

Perhaps the most difficult type of self-employed arrangement for lenders to assess are Limited Liability Partnerships.

With a partnership you will normally take your income from the net profit generated by the partnership. This is simple enough for a lender to ascertain.

The difficulty lies in the liability portion of the partnership as most partners, for example General Practitioners will have a legal liability to the partnership in a monetary value.

Once again, the way lenders reach their conclusion varies widely and each lender has a different set of rules they apply to get their income figures.

In terms of documentation though, lenders will still request your personal Tax Calculations and Tax Year Overviews. They may also scrutinise the Partnership Bank Statements.

Limited Company Directors

If you own more than 25% of a Limited Company, you are classed as self-employed by mortgage lenders.

Limited Company directors normally take their income by way of salary and dividends for tax purposes.

Immediately, lenders will have two separate classes of income to evaluate for affordability.

Other factors can also come into play too such as Director’s Loans and any personal guarantees a director has made.

Of course, a director’s income can be challenging to discern, but there are a few lenders who can account for your company’s net profit when calculating your own personal affordability. This can be beneficial if you have chosen not to take dividends and left money in the business accounts.

What Income Will Be Accepted for a Self Employed Mortgage?

As outlined, lenders have differing ways of treating self-employed income and it is a great idea to discuss your financial situation in full with your mortgage broker so they can match you with a lender best placed to accept an application.

Operating Profit

A bugbear for most self-employed sole trader and partnership owners trying to obtain a mortgage is most lenders will only accept operating profit. Operating profit is after expenses but before tax, which is the figure shown on the Tax Calculation document.

Self-employed people tend to submit all expenses they are entitled to reduce their tax burden, but counterintuitively lenders do not view this practice favourably for mortgage applications.

In fact, when applying for a mortgage, the incentive is reversed with many self-employed people reducing the amount of expenses they claim in order to increase their operating profit.

When you consider that most lenders require tax documents over several years, this can expose self-employed people to much higher taxation to satisfy a mortgage lender’s affordability criteria.

As a general rule though, you should expect your operating profit figure to be used for affordability calculations if you are a sole trader or partnership owner. If you are concerned about your tax liability or the amount of expenses, you are submitting prior to a mortgage application you should discuss your situation in full with a tax adviser or accountant.

Salary and Dividends

Directors will typically take their salary up to the tax-free allowance and then take the rest of their income as dividends because the tax rate on dividends is lower than income tax.

This practice has been the norm and is recommended by most accountants because it is the most tax efficient way for a director to take income.

Most lenders will be happy to operate on that basis and assess affordability from both salary and dividends.

However, it is common for company directors to hold money in company accounts, preferring to maintain healthy accounts. This practice also prevents any further tax being charged as there is no taxable event when money is left in a company’s accounts.

There are a few lenders who understand directors may choose not to draw down money from their company and will instead use the company accounts to assess affordability.

This is done by the lender apportioning how much of that money is potentially available to a director by shareholding and then using this figure for affordability. The way these particular lenders view those funds is the money is always available to a director so it should be classed as income.

Unusual Income

Self-employment often means obtaining income from a variety of sources, some of which is overseas or taxed in different ways.

Lenders treat unusual income in various ways with some declining it altogether and others considering all or some of it toward your affordability calculation.

Tax Credits and Mortgage Applications

Until last year, tax credits have been available to a large portion of the self-employed population. Tax credit income has sometimes been accepted by lenders and sometimes discounted.

The government recently changed the rules around tax credits and have started a migration to Universal Credit.

This migration may cause an unexpected problem with your mortgage application as there are some lenders who accept tax credits as income but do not accept Universal Credit as income.

If you are hoping to use tax credits toward your mortgage affordability, you should outline this to your mortgage broker. If you have subsequently migrated to Universal Credit, you should make your mortgage broker aware as this might prohibit an application with a lender you had previously looked at.

Self Employed Documents Required for a Mortgage

Providing you can show definitive evidence of your income to a mortgage lender, you should find the process of obtaining a mortgage straightforward.

Lenders will only accept specific types of documentation to verify your income.

Tax Calculation & Tax Year Overviews

Each year after the submission of your Tax Return to HMRC, a Tax Calculation and Tax Year Overview is generated for your personal records.

The Tax Calculation is a summary of your income and where it has been sourced from. For example, if you have received money from property, dividends, salary, etc, these income sources will be separated on the Tax Calculation.

The Tax Year Overview is a simple summary sheet outlining the Tax payable/paid based on the Tax Calculation.

The mortgage lender will request your personal Tax Calculation & Tax Year Overview documents regardless of whether you are a Sole Trader, Partnership and Limited Company owner.

Company Accounts

For LLPs and LTD Companies, your company accounts may be requested by a lender.

Typically, the documentation preferred is official documentation compiled by an accountant and some lenders will reject accounts that have not been created by a professional.

This is to ensure the accounts have been scrutinised properly prior to a mortgage underwriter evaluating them. If you do not use an accountant for your company accounts, you should raise this with your mortgage broker in the first instance as it can impact the lenders available to you.

Verified Accountant Letters

During the course of mortgage underwriting, you may be asked to provide a letter from your accountant. This is particularly the case if you have had a sudden drop or increase in profits, or a lender does not feel the existing evidence is enough to gauge your income.

An accountant may be asked to provide business projections or give insight into why income figures have changed year on year.

It is highly unlikely that a letter from your accountant will be enough to secure a mortgage alone and normally these letters are treated as supplementary evidence to bolster your initial income documentation.

Self-Certification and Mortgages

Historically, a self-employed borrower would be able to tell a lender how much they earn and then sign a document to state the information provided is honest and accurate.

This was known as self-certifying and allowed self-employed people an easier route to a mortgage. Unfortunately, a few borrowers ruined it for the wider self-employed population by declaring fictitious figures and committing mortgage fraud.

Lenders decided this practice was too risky and abandoned it, opting for official documentation instead. You can no longer self-certify a mortgage in the UK.

Self-Employment Credit Scoring

Like employed borrowers, you will be credit checked as a self-employed person.

This can prove problematic for some people as the line between personal expenditure and business expenditure can be blurry, especially if you are a sole trader. Be aware any borrowing for your business done under your personal name will factor into your credit score.

You should avoid taking any finance prior to a mortgage application as it can significantly reduce the amount you are able to borrow.

If you are worried about your credit score, advise your mortgage broker. It will be beneficial to forward your credit report onto your broker and they will be able to provide advice accordingly.

Sometimes a mortgage broker will ask you to repay any debt where possible or give insights about how you can improve your credit profile.

There are a handful of lenders who may accept bad credit scores and self-employment but the interest rates on these mortgages tend to be much higher compared to more mainstream lenders.

Lenders and Self Employment

A common mistake is to walk into your local bank or building society branch as a self-employed person and seek a mortgage.

You are essentially gambling that your income and self-employment will be sufficient for that particular lender and the interest rate you get is competitive.

You should speak to a whole of market mortgage broker, even if you have been accepted by your bank or building society. A mortgage broker has a duty of care to provide you with the best product and if you are lucky enough to have already found the best, they will tell you.

To put this into perspective, one of the absolute best lenders currently for self-employed people is not available on the majority of highstreets, but your broker should have access to them and will be able to provide a comparison across the whole market.

Speak to a Self-Employed Mortgage Expert

Boon Brokers is a Whole of Market Mortgage, Insurance and Equity Release Broker. Boon Brokers provides fee free mortgage advice and has extensive experience with self-employed mortgages.

Contact Boon Brokers to discuss your self-employed mortgage today.