Recent years have seen significant growth in people launching their own businesses. But what effect has this surge had on self-employed people’s ability to get mortgages?
The growth in the self-employed populace shows some correlation with post-credit crunch job losses. But the fall-out that ensued the 2008 collapse changed traditional employees’ attitudes.
People began to question job security; no one company was too big to succumb to wave after wave of recession. The mass migration produced an unprecedented result.
The CIPD‘s Autumn 2011 Labour Market Outlook reports 4.1 million self-employed in the UK. That’s a record level, which equates to staggering 14.2% of the working population.
The question is: have mortgage lenders’ attitudes to self-employment changed, given this seismic shift?
Table of contents
- Looking After Number One; Do You Know How?
- Self Cert Mortgages | Now You See Them, Now You Don’t;
- People Abused Self-Certification, Across the Board;
- Self-Employed Mortgage Applicants DO Have Options!
- What Will Lenders Look At To Prove Self-Employed Affordability?
- Underwriting is Key;
Looking After Number One; Do You Know How?
Who’d risk going it alone otherwise?
But it does also mean that you have to take care of personal finances.
You would have taken many factors for granted whilst you were in direct employment.
Now, the onus is on you.
You find yourself responsible for setting up and monitoring your own:
- income protection;
- life insurance;
- pension contributions;
- (and lest we forget) income tax and national insurances.
These are the absolute basics of covering your financial bases.
But it’s also imperative that you understand how to get a mortgage if you’re self employed.
Self-employed professionals, contractors, freelancers, sole traders and limited company directors all find it tough.
One reason, amongst others, is the disappearance of the self-cert mortgage.
So, who can you turn to for advice, now that High Street lenders adopt stricter lending criteria?
Self Cert Mortgages | Now You See Them, Now You Don’t
Before the credit crunch, most High Street lenders offered specialist self employed mortgage products. The industry termed this product a self certification, or “self-cert”, mortgage.
Lenders offered self-cert to anyone who couldn’t provide evidence of their income. This included those new to self-employment. Without the obligatory three years’ accounts for mainstream mortgages, it was the only option. But it wasn’t a barrier.
The only verification applicants needed for this mortgage was to “self-certify” their income. Lenders didn’t even ask them to provide evidence using accounts.
The problem was, many prospective homeowners inflated their income to borrow greater funds. Thus, it didn’t take long for self-cert mortgages to earn the moniker, “Liar Loans”.
People Abused Self-Certification, Across the Board
Approximately one million people took out these types of mortgages. This included people who were employed, but wanted to borrow more than otherwise they should!
In the run up to the credit crunch, more than 50% of all new mortgages were of the self-cert variety!
Because of their poor performance, Self Certification mortgages found themselves outlawed in October 2009. The now-defunct FSA accused lenders of using self-cert to avail customers of easy borrowing.
Rather than face the FSA’s wrath, mortgage lenders took the easy way out. They didn’t try to improve the product, instead withdrew self-cert altogether. That was several years ago.
The High Street is yet to replace self-cert with a bespoke ‘self-employed’ mortgage.
The Financial Conduct Authority Standpoint on Self-Cert
The FCA, FSA’s successors, is resolute that lenders verify all mortgage applicants income. This is to ensure that new mortgages are a realistic match to applicants’ affordability.
The problem self-employed people face today is proving the aforementioned affordability. It’s especially true for freelancers and contractors operating through their own limited company.
The calculations most lenders adopt use salaried pay as the basis of their formulae. This doesn’t work for tax-efficient company owners!
Their ‘take home’ is low on purpose, to maximise the tax breaks availed of limited companies.
Lenders don’t train in-branch staff to determine that contractors’ affordability lies in retained profits. Try to match limited company accounts against their calculation, it often ends in rejection.
Self-Employed Mortgage Applicants DO Have Options!
Getting a mortgage if you’re self-employed isn’t impossible. If you’ve been self-employed for three years or more, you should be fine. This is sufficient proof for to access most rates offered by mainstream lenders.
However, your approval will depend upon your circumstances and which lender you approach.
This has never been truer than during the COVID-19 pandemic. Mortgage lenders are changing their criteria daily, and for everyone.
In the absolute majority of cases, it’s better to use a specialist mortgage broker. They have a deep understanding of the way self-employed people work. They also know what lenders will accept as verification of income for lending purposes.
That’s the difference between bespoke brokerages and the High Street. All too often, in-branch advisors don’t know where to start on 3 years’ worth of trading accounts.
Mortgage Advice for Owners of Young Self-Employed Businesses
The self-employed struggle with mortgages most often when they’ve traded less than two years. But that wouldn’t be a barrier for a specialist self-employed broker. Such brokers should deal with lenders who consider businesses less than two years old.
This, believe it or not, is the easier part of the quest for securing a mortgage. The trickier part is understanding each bank’s lending criteria. In particular, how they will appraise your accounts or tax self-assessment for affordability.
Your trading structure makes a difference. Each lender’s affordability criteria and requisite documentation for assessing earnings will differ for:
- sole traders;
- limited company contractors/freelancers;
- company directors.
At this point in the application process, talk to a self employed mortgage specialist. Their accrued industry knowledge will help them know which lenders to instinctively approach.
Your circumstances are unique. Depending on what they say could make any one of many different lenders most suitable for you. An initial expert assessment could save you lots of time and needless disappointment.
What Will Lenders Look At To Prove Self-Employed Affordability?
Company directors and sole traders operate in different ways. Sole traders are responsible for the debt at a personal level. With limited company directors, their business takes on the debt as a separate entity.
As such, banks appraise their profit and circumstances in different ways.
If you’re a Sole Trader, lenders will examine the net profits of the business. Or, if you’re self-assessed for tax, they’ll use the income stated in your SA302 form.
Some High Street lenders, e.g. Halifax and Kensington Mortgages, will even accept one year’s accounts. But you might struggle if you approach them in branch, direct.
Mortgages for company directors operating through a Limited Company can be altogether trickier. The majority of lenders ask to see at least two years’ accounts. Plus, they will only take your salary and dividends drawn to assess your affordability.
As a limited company director, your borrowing potential isn’t apparent to them at all. While tax-planning is acceptable practice across our industry, it’s lost on many mortgage lenders.
But this strategy does have the undesired consequence of reducing your potential for borrowing.
This is yet another area where banks and building societies are behind the times.
The increment in self-employed people in the UK shows no sign of stopping. Contractors and freelancers are also seeing the sense in forming their own limited companies.
You’d think lenders would realise the market potential their outdated policies are ostracising. If the penny has dropped, it’s yet to roll its way down to branch level.
Don’t Make Assumptions: Get a Bespoke Quote
Not all small business owners operate and trade in similar fashion. Your acceptance for a mortgage will depend on your bespoke circumstances. In a guide like this, we can only present generic advice based on our experience.
How your drawings reflect your true earnings will determine how much you can borrow. A specialist broker will know how to present your information to show your true earnings.
Underwriting is Key
Underwriters are busy people and only want to see the information they need. Not sending them reams of accounts is often a positive move.
Some lenders use a combination of net profits before tax, plus your director’s salary. This rarely works anywhere but at underwriter level for the vast majority of lenders.
It does allow you to borrow much more than if they used drawings alone to work out your affordability. It’s also more favourable–and perhaps more accurate–as a way to determine your financial clout.
This type of underwriting reflects both your true earnings potential and incorporates retained profits. In effect, it embraces tax-planning rather than punishing you/your accountant for being savvy.
Appealing to an underwriter’s better nature
But please understand this, too. The same underwriters who confirm your affordability also wield the power of mortgage approval.
It’s critical to your success that you use the tried and trusted method. Approach them through a specialist who can present your earnings in the best light.
They often base how much you can borrow on your last fiscal year’s accounts or the past few years’ average.
If your accounts show progressive growth, they often use the most recent year’s figures. In contrast, if your accounts are erratic, they’ll consider your average income.
Through regulated specialists brokers, underwriters are working to bridge the gap. Until banks adopt wider acceptance of self-employed income, access to funds will remain guarded.
So even if, at branch level, it seems banks aren’t making much headway, at a higher level they are. It’s just that they’re so aware of FCA guidelines, they have to exercise caution.
By operating through self-employed mortgage specialists, they are working it out. One step at a time maybe, but at least they’re now heading in the right direction.
John Yerou is a pioneer of contractor mortgages and owner and founder of Freelancer Financials, Contractor Mortgages®, C&F Mortgages and Self Employed Mortgages, trading styles and brands of the award-winning Mortgage Quest Ltd.