Getting a home loan if you are self employed can be challenging. Here are answers to some frequently asked questions.
How long do I need to be self-employed for?
To get a self-employed home loan, the majority of lenders require you to be self-employed for at least two to three years.
What mistakes do banks often make?
We often see mistakes in the way that the banks calculate the income for self-employed borrowers.
For complex loans, we make extensive notes, and if need be, call the assessor and walk them through the financials to ensure that they assess the loan correctly.
The most common mistakes we see are:
Lack of understanding: Complex trust structures with multiple companies and trusts are often handled by bank staff that lack the experience to understand what’s actually happening with your income or if you’re using income protection payments. In these cases, we’d talk to your accountant and then talk to the assessor to ensure they understand exactly what’s going on.
Double dipping: This is where the lender takes an income into account twice (e.g. Net Profit Before Tax and also accepting the dividend paid to a director) or takes an expense into account twice (e.g. forgetting to add back interest on loans).
Company car: Lenders regularly ignore the benefit a self-employed person receives from tax deducting their car expenses in their company. We always draw their attention to this in our notes.
Procrastination: Technically this isn’t an error as it’s done on purpose! If your loan is particularly complicated then we find that bank staff may take their time to get to your application. We usually speak to management and ask them to assign your loan to an experienced assessor who will enjoy the challenge of a complicated application.
How do lenders calculate my income?
Most lenders believe that by looking at your past tax returns they can predict how stable your business will be in the future.
Banks and non-bank lenders alike tend to be very wary if you have an income that has increased or decreased by a large amount in the last two years.
One lender may use the lowest of the income figures for the last two years.
Another may use the most recent year’s income as shown on your tax return.
Some may even average the two years income or take 120% of the lowest year’s income.
They may or may not then add back expenses shown on your returns.
As you can imagine this makes a big difference to your loan application! Importantly, every lender will interpret your tax returns in a different way and may look at your skills as an entrepreneur, your experience in the industry and the risk profile of your industry to determine how to assess your income.
Depending on your situation, we may pick and choose which information to provide to help prove the highest possible income. If you can provide them, then we may ask for Business Activity Statements (BAS), An Australian Taxation Office (ATO) tax portal printout or bank account statements for the last three to six months showing your turnover.
What do lenders think?
Lenders have the view that self-employed borrowers represent a higher risk because their income isn’t as stable.
Some banks even view those in the construction industry less favourably than those from accounting firms. This is simply because banks have seen higher levels of default over the years from particular industries so tend to be more conservative when lending to them.
At one time, a leading mortgage insurer even refused to approve low doc loans for builders!
As you can see, the banks complete a more thorough assessment of applications from business owners.
How will lenders view my tax returns?
When a credit officer working for a bank receives your tax returns on his desk he’ll check to make sure they’re signed and certified and backed up by notices of assessment. This is a simple fraud check to make sure that these are the tax returns you lodged with the ATO.
Next, he’ll usually look at the last two year’s taxable incomes and add back any unusual expenses such as one-off losses.
Did you know some lenders will add back extra super contributions and even depreciation?
This is where the banks really show a large difference in the way they read your tax returns! Banks will also have different documentation requirements depending on if you’re a company, trust, partnership or sole trader. They may ask for interim financials or cash flow projections, depending on the nature of your business and the risk of your application.
How recent are your tax returns?
By March or April each year most lenders begin to ask for tax returns for the most recently completed financial year. Up until that point, you can provide the tax returns from the year before!
So, for example, if you applied in January 2015 most lenders would require your tax returns for 2012 and 2013, however in March 2015 most lenders would require 2013 and 2014 returns.
Of course, there are always exceptions! One of our lenders can accept older tax returns as an exception to their normal policy. This is useful for people who haven’t had a chance to lodge their most recent return.
One of our other lenders only requires one years’ tax returns. This is useful for people who have had a bad year the year before or who only recently started their business.
What is an “add back”?
Your taxable income alone isn’t the same as the actual income that you can use to pay your commitments, including the repayments for the new mortgage. So lenders add back any expenses that you’ve incurred that reduced your taxable income, however, isn’t a “real” expense or ongoing commitment.
By adding back expenses you can increase your assessable income and your borrowing power!
Some examples of add backs are:
Depreciation: Depreciation is a tax deduction, however, isn’t a day to day expense. For this reason, some lenders add it back to your taxable income.
Additional superannuation: If you’ve made lump sum contributions to super in excess of your minimum requirements then these can be added back.
Net Profit Before Tax (NPBT): If you have profits that you’ve retained in your company then these can be taken into account as well. If you don’t own the entire company then lenders will assess your share of the net profit.
One-off expenses: If you had an extraordinary expense then we can often add this back. We may need an accountant letter to confirm this.
Interest expenses: If you have a business loan or investment loan then it’s likely that you have tax deducted the interest that you have paid. We can add this back as lenders will assess all commitments that you have separately in their serviceability calculator.
Rental property expenses: Depreciation on your properties, management fees, repairs and other rental property deductions such as negative gearing are all added back. Rent income is also deducted from your income as lenders assess this separately to your main income.
Company car: If you have a car that’s used by your business and yourself then it’s likely that you have tax deducted many of the expenses associated with this car. Lenders don’t add this back, however, they’ll often add in an extra $3,000 to $6,000 in income to compensate for this.
Trust distributions: If you have your business in a discretionary trust and have chosen to distribute income to some of your family members then in most cases this can be added back. Note that many lenders don’t accept this add back, or will only do so if you provide a letter from your accountant to confirm that the beneficiaries aren’t financially dependent on this income.
As you can see, this can get quite complicated! As a result, many bank employees make mistakes when assessing your income.
Low doc options
Most lenders these days will allow you to not submit tax returns or financials if you sign a declaration confirming your income.
The lender can then assess your loan using the declared income.
Although most lenders don’t charge a higher rate for low doc loans they may charge you Lenders Mortgage Insurance (LMI) as a one-off fee when the loan is set up.
This fee is usually charged for loans over 60% of the property value.
Avoid business banking
If you’re borrowing in a company, trust or partnership then you may get referred to business banking. Avoid this at all costs!
If you have a residential property as security then why should you pay a higher rate and higher fees just because you’re borrowing in a company? Your loan may be a business loan, however, the risk to the lender isn’t any higher than for a standard mortgage!
Some of our lenders will approve company home loans and trust home loans at standard residential rates.
You may have to pay slightly higher fees so that the lender can draw up more extensive loan documents which encompass a personal guarantee from the directors.