Lending to Self-Employed Borrowers
Most lenders will lend to the self-employed and base the borrower’s affordability to service the loan on their net profit before tax.
However, how each lender calculates a net profit figure for borrowing purposes varies. It also depends how the borrower operates his business – as a sole trader or through a limited company.
Most lenders will take the average of the last two years’ profits but if your profits are down year-on-year, they will use only the latest year.
Other lenders will use just the latest year’s figure regardless.
Directors of limited companies (where the borrower owns 20% or more shares)
Most lenders will use the director’s salary plus dividends. Again, some lenders will take an average of the last two years’ salary and dividends if the amount has increased year-on-year but only the last year’s salary and dividends if the amount has decreased. Other lenders will only use the latest year’s figures regardless.
However, it’s also the case that a few lenders recognise that a director may not need to withdraw all the profit as salary or dividend thus reducing their personal tax liability.
In these circumstances these lenders will allow the affordability calculation to include salary plus a share of the net profit for the director, which, in turn, sometimes allows the director to borrow more than normal.
Recently a couple approached to remortgage their property.
The husband owns 56% of a limited company which has been trading for 9 years. He earns a salary of £8,500 per year plus dividends of £31,000 giving him a total taxable income of £39,500.
The husband’s salary and dividends would support a loan in the region of £190,000.
However, the company generated a profit in excess of £120,000, so when I analysed how much this alternative calculation could mean they could borrow this figure increased to over £400,000 for the clients….more than doubling their potential borrowing capacity!
In these types of scenarios, understanding which lender to approach is crucial, so if you are self-employed and need some advice or guidance, please do get in touch.