What do lenders base self-employed residential mortgage affordability calculations on? Most lender’s base their mortgage affordability calculations on your business’ net profit figure, before tax. However, how this is calculated varies from lender to lender and also depends on how your business operates; whether you’re a sole trader or the director of a limited company.
Many lenders will simply use the business’ latest year’s net profit (either from accounts or tax computations) figure to calculate the affordability. However, some lenders will vary their assessment depending on your profitability over the last couple of years, This is why you usually (but not always) require two years of accounts for residential mortgage applications.
If profits have been increasing year on year, some lenders will take an average of the last two years and base their mortgage affordability calculations on that. If profits have been decreasing for justifiable reasons, then they’re likely to base the calculations just on the latest year’s accounts.
Directors of Limited Companies (with 20%+ shares)
For directors of limited companies, the majority of lenders will base residential mortgage affordability calculations on your salary plus any dividends. As with Sole Traders, if the total of your salary and dividends has increased year-on-year, lenders will use an average of the last two years, however, if there has been a decrease, they will just use the most recent year’s values. Again, other lenders will use the previous year’s regardless.
Some lenders recognise that as a director you may not withdraw all the profit as salary and dividend to reduce your personal tax liability. In these cases, the lender will base the mortgage affordability calculation on your salary plus a share of the net profit for the director. They are likely to request copies of the company accounts for confirmation. The benefit of this is that it can sometimes allow you to borrow more than on the salary and dividend basis.
Case Study: Couple Re-Finance to Pay Off Large Bridging Loan
The Clients: A married couple in their 60s, who owned several buy to let properties. The husband was also the director of a Limited Company which had been operating for 5 years. He took a salary of £9,000 and dividends of £37,000, making his total annual taxable income £46,000.
The Property: The couple lived in a 4-bedroom terraced house in London which had a substantial amount of equity in it.
The Finance: The clients had an expensive bridging-loan secured against their London home, which had been used to fund improvement works on their buy to let properties. As a result of the refurbishments, the buy to lets had not made much profit that year, which meant it was cheaper to re-finance their residential home.
The Challenge: Based on the husband’s salary and dividends, we were only able to secure a loan of £230,000, which was not enough to cover the bridging loan they needed to pay off.
The Solution: Because the husband’s limited company had generated a profit of over £180,000 the previous year, we approached a lender which we knew would take the company's profitability into account when completing their mortgage affordability calculations. Based on this, we were able to secure a loan offer of £570,000 – 148% more than before! Our clients were thrilled with the increased loan offer and were able to secure an interest-only mortgage with a very competitive rate and low monthly repayments.
If you’d like to know more about applying for a residential mortgage when you’re self-employed, you can see our guide of the whole process here, including what you’ll need to make your application.
This article was updated on 10/01/2020.
Alternatively, you can email me RossM@mortgagesforbusiness.co.uk
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