Complicated incomes & self employed
DATE: 4 October, 2021 // Read more from the Blog »
Regulation changes to affordability & self employed
The regulator has created a lot of additional regulation since the credit crunch which has practically outlawed self cert mortgages, and made the assessments far more sensible. For example, they now only want people to take on a mortgage they can afford, Imagine that? Now whilst many people weren’t too badly affected by these regulation changes others have been caught out and stung as they’re unable to attain a mortgage they can afford but perhaps can’t prove it. There are various scenarios where this could apply such as where someone is being gifted money on a regular basis by family, or perhaps they have an enormous amount of savings but don’t want to buy the property cash. Both very uncommon, but the argument is the gift could stop or the magical pool of money could run out leaving the person with no means to maintain the debt. It’s also affected the self-employed too, the lenders typically want you to be self-employed for at least 2 years but there are some that will consider 1 year self-employed, and there are circumstances where less than that can be considered but again these are few and far between; like a solicitor buying in to an existing law firm. So nowadays mortgages are based on your ability to actually repay the debt in a realistic manner, generally referred to as ‘affordability’ so not all bad.
I'm a sole trader, does that make a difference?
As a sole trader you can still get a mortgage but the paperwork to prove your income is different to that of an employed person. Typically, the lenders ask for tax calculations (formerly SA302’s) and the corresponding tax year overviews. These can be downloaded from the HMRC or your accountant should be able to provide copies if you have one. You can use the full accounts too but from my experience the tax calculations and tax year overviews tend to raise less problems. Most lenders will want the average of the last 2 years whichever documentation you use, some will want more. There are lenders that accept the latest years figures and some that will accept 1 year trading, but if you have more than 1-year trading they typically want the latest 2yrs figures. They will typically work off an average of your last 2 years figures if the net profit is increasing, or the latest if its decreasing. Most lenders will work off your share of the net profit if you’re a sole trader or a partnership. If your income has increased significantly, even those that work off the latest years figures may then apply an average if they feel there is a risk the surge in income isn’t sustainable. Once you have the relevant figure the amount you can borrow will typically be treated the same as an employed person.
There can be alternative ways of proving your income when self-employed, some lenders will allow an accountant’s reference to clarify the income. The accountant will need to be sufficiently qualified and typically chartered. If they don’t have an acceptable qualification, it may as well be written in crayon as it will carry no weight with the lenders. The same way that if you had a nasty rash, you would speak to a doctor and not Dave from the pub.
If you are a contractor or paid via CIS (Construction Industry Scheme) there are different ways we can look to assess income too and sometimes these scenarios are allowed with a shorter time trading, but they typically want you to have the relevant experience first.
I own the company I work for, am I employed or self-employed?
For most lenders, if you own 20-25% or more they will treat you as self-employed. If it’s a limited company there are different ways proving your income. Banks have different ways of assessing the income, some work off your salary and dividends, others your share of the net profit. There are other options too but these are the main 2.
You can use the full accounts or the tax calculations and tax year overviews. The latter tends to be easier and less problematic as there is less information. The full accounts can sometimes offer further borrowing if you aren’t taking your full entitlement. Retained profit usually isn’t expected and the banks typically want to work off the latest of your last 2 years figures. This is because they need to know the money is sustainable, if you’re drawing more than you are earning eventually the money will run out.
Its also possible to use an accountant’s reference for some lenders, in some circumstances these are mandatory or preferred as the accountant can provide an explanation where needed. For example, if you’ve bought a new work vehicle or premises the profit for that year might have taken a major hit. If you can prove that or the accountant can write something to that effect you might ignore the drop or even work that figure back in. the accountant would need to be sufficiently qualified though and typically chartered.
Self-Certification Mortgages aka ‘Self-Cert’
Back in the day, pre-2008 credit crunch it was much easier to arrange a mortgage as there was much less regulation as well as an attitude that all will be well. It was even possible to arrange a ‘self cert’ mortgage whereby a person could literally say, “I can afford that.”, and they would get the mortgage. Quite often there was no rationale needed, it could be arranged on interest only so the person ‘may’ be able to maintain the payments but had no real prospect of repaying the debt. Often people would sit on these interest only mortgages until they got to a point when the term ran out and the lender demanded their money back. Oh dear. Hindsight is a wonderful thing they say but unfortunately you can’t turn back the clock and if you get to retirement age with no means to repay the loan you will likely be forced to sell the property and vacate. Hopefully you will have sufficient equity to buy another property, but if not, you’re facing a difficult situation.
So, for the above reasons, self cert mortgages are practically outlawed and you need to be able to afford the mortgage you’re applying for.
Can I get a mortgage whilst I use a tax avoidance scheme?
If you’re involved in a tax avoidance scheme, assuming its legal the lender won’t automatically decline you. However, if the provable income that the lenders will accept is low as a result this could affect the amount you could borrow. This should be considered before you get involved but often once in, its not a quick process to undo as the banks will typically want 2 years figures for the self-employed.