Getting a mortgage can be a daunting experience for anyone, but it can be especially challenging if you are self employed. Unlike salaried employees, lenders view your income differently, which often leads to confusion and complications. To help you navigate this process with ease, we have put together the following guide to mortgages for the self-employed. Here we aim to explain everything from eligibility criteria to the deposit amount you'll need and the amount your lender is likely to offer you.
Eligibility Criteria
Did you know that you may be eligible for a mortgage even if you've only been in business for a year? While most lenders prefer to see at least two years of history, there are some who are willing to make an exception.
If you own more than 20% shares in your company, lenders will generally classify you as self-employed.
What Income will be used?
If you are a sole trader it is simple, lenders will use your Net Profit as shown on your Tax Calculation.
However, understanding how lenders assess your income can be confusing if you are a company director. It is crucial to understand your income and how lenders use it to determine the loan amount you qualify for:
Some lenders work using your Net Profit and Directors Salary
A small number may even use your Gross Profit and Directors Salary & Pension contributions
However, many lenders only take into account your Dividends and Directors Salary
As you can see, your business's performance and the income you draw each year can play a huge role in determining your borrowing capacity. If you are a director drawing only what you need and retaining a healthy profit year on year, working with lenders who operate based on your company’s profit is likely to be your best route to maximising your borrowing capacity.
What paperwork will lenders ask for?
This will vary from lender to lender but, as a general rule of thumb, you will need to supply the following:
Sole Trader: you will need to provide your most recent Tax Calculations and Tax Year Overviews (TYO’s), usually the last three years – you can obtain these from your accountant or online via the Government Gateway.
Company Director: as above so your Tax Calculations / TYO’s. However, if you are keen to use your share of Net/Gross Profit you will need to supply full and completed company accounts, usually covering the last 2-3 years - some lenders will ask your accountant to complete and return a specific reference letter or certificate. Business bank statements can sometimes be requested to back up your income too.
You will need to supply some other documents as part of your mortgage application, check out What Documents Will I Need To Provide For My Mortgage Application for full details.
How Much Can You Borrow?
When determining affordability for a mortgage, lenders typically consider the average of your most recent two years of income. However, if there has been a significant drop in the latest year's results, some lenders may only take that year into account. Conversely, if you've had a much better latest year, certain lenders may consider using that figure.
It's important to note that there isn't a simple answer to how much you can borrow, as several factors come into play. These include your existing loans, financial commitments (including dependents), and other variables that can impact the loan amount offered. As a general guideline, a few lenders might consider offering up to 5.5 times your income, but it's often advisable to err on the side of caution, as most lenders tend to work around the 4.5 level.
The mortgage term will also have a say in how much you will be offered – so if you are looking to take a mortgage over 15 years and with some commitments in the background, it is unlikely that you will be offered anywhere near at the levels noted above.
Lastly, your deposit plays a crucial role in determining the amount a lender will consider offering you. The more you can put down, the lower the risk for the lender, which can in turn increase the options and amount available to you.
Deposit Amount
In recent years, especially after the impact of covid, self-employed individuals have generally been required to provide a higher deposit compared to salaried employees. Some lenders would expect you to put down a minimum of 25% of the property's value.
However, the good news is that many lenders are now becoming more flexible in this regard and are now willing to support you with a deposit as low as 5% of the purchase price. At this level, you would be seeking a mortgage equal to 95% of the purchase price, which is commonly referred to as 95% 'Loan to Value' (LTV). It's important to note that with a 5% deposit, your options may be somewhat limited. Additionally, you will likely encounter higher interest rates and stricter criteria from the lender. It's important to understand that a higher deposit reduces the risk for the lender, allowing for greater flexibility and improved interest rates.
Repayment Term
Lenders typically allow mortgages to span between 25 to 40 years – it is advisable to ensure that it does not extend beyond your 75th birthday, some lenders will restrict to your 70th birthday. It is crucial to factor in your planned retirement age in order to avoid mortgage payments extending beyond that time. If you are not primarily engaged in manual work, some lenders may consider extending the mortgage term until your 80th birthday. However, it is usually preferable to aim for an earlier mortgage repayment date.
Whilst extending the term can result in lower monthly repayments, it may also provide some 'financial room' to focus on developing your business. It is important to consider that most lenders offer flexibility by allowing annual overpayments. Remember that extending the term does not have to be a long-term decision. It can provide temporary breathing space to concentrate on your business, with the option to reduce the term by making overpayments when the time is right for you.
In conclusion, getting a mortgage as a self-employed individual requires a bit of extra work and preparation, but with the right guidance from a mortgage broker, it really can be a smooth process. Understanding the lender's eligibility criteria, how much deposit is required, considering the maximum amount you can borrow, comparing interest rates, and determining the appropriate repayment term are all essential factors. Be sure to work with a mortgage broker who understands your unique needs. Armed with this knowledge, you'll be able to secure the right mortgage with relative ease.
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Published by Beechwood Mortgages Ref: 219335 with review and approval from Stonebridge Mortgage Solutions Limited who is authorised and regulated by the Financial Conduct Authority Ref: 454811.