How do banks look at self-employed income?
By Rhys Edwards
I speak to many clients that have spoken to the banks directly and have come away either feeling like they cannot get a residential mortgage, or they cannot afford the property they have found.
The good news is that many banks have different ways they look at self-employed income. Here are a few highlights via some questions and answers from the marketplace.
What documents can be used for the assessment of income?
| Sole traders | Subject to the lender, you will need to provide either an accountant’s reference confirming income or the tax computation and tax year overview (these are the documents produced after a tax return is filed). |
| Limited company director with shares over 25% | Banks can use company accounts as proof of income or the tax computation and tax year overview. |
| Self-employed contractors | May be able to use the contract documentation, even if contracted on a self-employed basis (this is dependent on the value of the self-employed contract). |
| LLP Partners | Will be treated as employed, and a letter from the practice manager is required to confirm income level and contract details. This is the same even for new partners with less than a year in the partnership (as long as the partnership has been trading for longer than two years). |
How many years of trading/accounts are needed?
- Most banks require two years of full accounts or tax documents, but in some circumstances, a small number of lenders may accept a minimum of one year with a projection prepared by a qualified accountant.
What income can be used and how do banks use the income?
- Sole trader – the banks will use the total income shown on the tax computation (this can also include any profit from land property with some banks).
- Limited company director with a shareholding of 20% plus (25% with some banks) – the banks will use dividends, and salary is drawn as per the accounts and backed up with the tax computation and tax year overview documents.
- However, for limited company directors who do not draw all the possible income from the business, some banks will use the salary and the director’s share of the net profit showing on the accounts.
- Most banks will average the last two years of income figures mentioned above; however, some can also use the most recent year if this figure is higher (subject to supporting evidence).
Examples;
| 1 | A sole trader with an income declared on the tax documents of £75,000. A lender will use a total income of £75,000, with no major outgoings or credit commitments; this would provide a maximum mortgage in the region of £336,000 over a 25-year term (calculated on Legal and General affordability calculator as of 05/10/2023). |
| 2 | A company director with a 50% share in a company receives a salary of £25,000 and draws dividends of £50,000 (averaged over the last two years). A lender will use a total income of £75,000, with no major outgoings or credit commitments; this would provide a maximum mortgage in the region of £336,000 over a 25-year term (calculated on Legal and General affordability calculator as of 05/10/2023). |
| 3 | The same director has a net profit share of £100,000 (again averaged over the last two years accounts but has only drawn £50,000 in dividends). In this scenario, a lender will use the net profit rather than the dividends income, which would mean a salary of £25,000 but would allow the share of net profit of £100,000 to be used, giving a total income of £125,000. This means the maximum borrowing over 25 years would be in the region of £556,000 (calculated on Legal and General affordability calculator 05/10/2023). |
| 4 | For contractors with a day rate, even if they pay themselves via a limited company, if the contract value is equal to or more than £50,000, most lenders will work from the day rate x 5 x 46 weeks. An example of this is a contractor paying themselves £30,000 per year from their own limited company, but they have a day rate of £400 per day. The lender would calculate the income as £400 x 5 x 46 = £92,000, meaning over 25 years, they could potentially borrow up to £428,000 (with no outgoings). |
So, ultimately, there are many choices for the self-employed. If a self-employed client is looking to borrow the absolute maximum, this may mean they are not eligible to the market leader on rates, but the above examples have been sourced from the top ten banks and lenders.