Self-Employed Net Profit Mortgage

How do you calculate affordability when using net profit as income?

There are multiple different ways of calculating affordability for the self-employed. If we take a sole trader, for instance, we’re mainly going to be using net profit from the company to assess the affordability.

If we take a limited company director, we could actually use salary and dividends or salary and retained profit, which is slightly different. Strictly speaking net profit is mainly relevant for sole traders, where that figure is used to assess the affordability.

How many years of net profit figures do I need to apply for a mortgage?

Two years would be great because that way we have a wide spread of lenders. Most will take two years worth of net profit into consideration.

That’s not to say you can’t get a mortgage if you’ve only got one year. It still can be done. It’s just going to limit the lender choice a little.

Do lenders use average net profits, the most recent year or over two or more years?

Lenders ideally want to see two years and they tend to use either the lower of the two, or an average. If your latest year’s net profits are lower than your first year, in most circumstances, banks will err on the side of caution. They assume that your latest year’s net profit is what’s going to continue and use that figure in the affordability calculation.

If you’ve only got one year’s worth of submitted accounts, they will use that one year and a prediction of your second year, plus your latest three months’ business statements to – hopefully – support that prediction.

How does my net profit affect the maximum mortgage I can get?

In short, the higher your net profit is, the more you can borrow. That’s similar to how it works if you were employed. The higher salary someone has, the more they can borrow from the bank.

Can I get different income multipliers based on net profits when applying for a mortgage?

Income multipliers are a little outdated now. Most people have heard that banks use 4.5 times your income to understand how much you can borrow, but that’s not necessarily the case any more.

For somebody with no debts whatsoever, no children and very little in the way of outgoings, lenders may well offer 4.5 or five times their income. But most customers have credit cards, personal loans, finance plans on cars or hire purchase agreements. They could be leasing machinery.

Many different factors can lower the income multiplier – so we don’t really like using that terminology. Too many things can lower it down. The best thing to do to figure out affordability is speak to a mortgage broker that really understands the self-employed market.

Through years of trading we understand which banks are more flexible for the self-employed and will offer a little more to those that need it.

Do lenders apply a lower income multiple for self-employed applicants?

No, they don’t. They won’t penalise you for being self-employed. The only thing they’re going to do is request a few more extra documents, to get a good grasp of how much you are earning over a two-year period – or possibly even one year, with a prediction of the second year.

Can you use projected income to get a mortgage?

Yes. If the latest year has not been submitted yet, we can use a projection. It’s very much down to the lender, though. Some allow it, some won’t. It’s best to speak to your mortgage broker to find out which ones can help.

If we need to use a projection, we can look at those lenders. But if we can get away with not using a projection, especially with a lender that will offer a lower interest rate, then we probably won’t use the projection income. We’ll probably just use the latest two years.

It’s only in the circumstances where we’ve only got one year’s worth of accounts that we would go down that particular route.

Is there a maximum loan to income (LTI) ratio when using net profit?

It’s very much lender dependent. What affects it is debt. It’s a similar situation to the income multiplier, as debts can have a big impact on how much a bank is happy to lend.

I don’t like saying that you can get five times your income because it can give you a false sense of how much you can actually borrow when looking at houses.

I would prefer to give a customer a realistic figure for how much they can borrow based on their debts and earnings. Then, when they are looking at properties, they know what value to actually go up to. They’re operating in a realistic environment.

Are there any minimum income thresholds for self-employed applicants?

No, but there will be a theoretical minimum income threshold for the mortgage that you want to achieve. If you want a larger mortgage of perhaps £500,000, the income needed is going to be a lot higher than if you wanted a £250,000 mortgage.

It’s very much down to the individual – we’ll assess it on a case by case basis. Again, debts have a big impact on how much you can borrow. If you’re coming to us with no debts whatsoever, you’ll be able to borrow more money than if you have PCPs and credit cards.

Are there different requirements for sole traders versus limited company directors?

Yes, there are different requirements. Strictly speaking, the documents required will be very much the same – two years’ tax year overviews and calculations and two years’ company accounts or tax returns.

We also need three months’ personal and business bank statements. That’s the same for a sole trader and limited company.

What does change is how affordability is calculated. For a sole trader, lenders will look at your net profits over the past two years. If it’s a higher amount in the second year than in the first, they’ll take an average of the two. Or, if the second year is lower, they may take just the lower net profit into consideration.

However, for limited company directors, that changes. The director is technically an employee of the limited company and receives a salary and dividends. The salary is often the equivalent of their tax-free allowance – roughly £12,500, and they’ll pay themselves additional dividends for tax efficiency.

You should speak to a tax advisor around how to actually pay yourself, not a mortgage broker. We just take the information that’s provided to us.

But the other way we can assess affordability for limited company directors is to use salary and retained profits.

If a business is earning £1 million a year, for instance, the company director may only need to pay himself £50,000 a year. It would be unfair for a bank to only take £50,000 as their affordability. So some banks will be more lenient in this circumstance – because this director could clearly pay themselves more than £50,000. So they take salary plus retained profits into consideration.

If I operate under multiple businesses, how do you assess total income?

I’ve actually got a customer who owns a window cleaning company and a gym. For them, we would assess the total income using their SA302s, which are made up of the tax overviews and calculations.

For both a limited company director and a sole trader, your tax calculation has a section called Total Income Received. That will be the total income from across all your businesses. And that’s what we would use to assess your total income.

How can a mortgage broker help here? Have you got anything else to add?

There are lots of caveats for the self-employed taking a mortgage, so the simplest way to find the right solution is to speak to a mortgage broker. We deal with this on a daily basis.

We’ll help you with your documents, and we know which avenue is best to get the mortgage you want.

An important aspect for the self-employed is protection. Limited company directors can put this through the business – paying premiums for life insurance, critical illness cover or income protection before tax and national insurance. That can be a lot more tax efficient than putting it though your personal bank account, where you have to pay tax on it.

For anything to do with tax advice, you should always speak to a tax advisor. They will tell you the best and most efficient way of getting the money into your personal account. But it’s always worth knowing as a self-employed director that there are ways to pay for your protection via your company.

YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP WITH YOUR MORTGAGE REPAYMENTS.

For specialist tax advice, please refer to an accountant or tax specialist.