In recent years, there’s been significant growth in the amount of people launching their own businesses in the UK. But what knock-on effect has this surge had on the newfound self-employed’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 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 the seismic shift?
Looking after number one; do you know how?
Being your own boss definitely has its perks. Who’d risk going it alone otherwise? But it does also mean that you have to take care of personal finances.
Many of these you would have taken for granted whilst you were in direct employment. Now, 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.
Besides the basics, it’s also imperative that you understand how to get a mortgage if you’re self employed.
Who can you turn to for advice, now that High Street lenders don’t particularly welcome self-employed professionals, the likes of, contractors, freelancers, sole traders and limited company directors with open arms? Let me just qualify that last remark.
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. Not having the obligatory three years’ accounts for mainstream mortgages, it was the only option.
But it wasn’t a barrier. The only verification applicants needed was to “self-certify” their income. Lenders didn’t even ask them to provide evidence using accounts.
The problem was, many prospective mortgagees inflated their income to access greater funds. It didn’t take long for self-cert mortgages to earn the unfortunate moniker, “Liar Loans”.
Approximately one million people took out these types of mortgages. Indeed, in the run up to the credit crunch, more than 50 percent of all new mortgages were of the self-cert variety.
As a result of poor performance, Self Certification mortgages found their way onto the scrap heap in October 2009. The now-defunct FSA accused lenders of using self-cert to avail customers of easy borrowing.
Rather than face their wrath, mortgage lenders took the easy way out and withdrew the product from their shelves. That was several years ago. To date, most High Street lenders are still to replace self-cert with a bespoke mortgage for the self-employed.
The Financial Conduct Authority Standpoint on Self-Cert
The FCA, successors of the FSA, is resolute that all lenders must now verify the income of mortgage applicants. This is to ensure that any new mortgage loan is a realistic match to the applicant’s affordability.
It’s no surprise to find that all lenders in the UK have ceased to offer Self Certified loans and mortgages. Period.
The problem self-employed people face is proving that affordability. It’s especially true for freelancers and contractors operating through their own limited company.
The calculations most lenders work to uses salaried pay as the basis of the formula. Tax-efficient company owners ‘take home’ is low on purpose, to maximise the tax breaks on offer.
In-branch staff are not trained to work out that a contractor’s affordability lies in retained profit. Try to match them against their calculation and it’s instant rejection.
Mortgages For The Self-Employed: You 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.
Your approval, however, will depend upon your circumstances and which lender you approach.
In the absolute majority of cases, it’s better to work through a specialist mortgage broker. They have a deep understanding of what lenders will accept as verification of income for lending purposes.
That’s the difference between them and the High Street. All too often, even in-branch advisors don’t know where to start with three years of trading accounts.
The self-employed struggle to secure mortgages most often when their business is less than two years old. But that wouldn’t be a barrier for a specialist self-employed broker. They should have access to lenders willing to consider less than two years trading history.
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 and freelancers;
- company directors.
It’s when you reach this in the application process that you must speak to a self employed mortgage specialist. Their accrued industry knowledge will help them know who to instinctively approach. Based on your unique circumstances, this could make any one of many different lenders most suitable for you.
If for no other reason, an initial expert assessment could save you lots of time and needless disappointment.
What Will Lenders Look At?
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 director, your potential isn’t apparent to them at all. While tax-planning is an accepted practice across the industry, it’s lost on mortgage lenders.
We know that most small business owners pay themselves low salary and limit dividend payments. It is a time-honoured and spectacular way to reduce your tax bill.
But in contrast, it 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 number of self-employed people in the UK continues to grow. Contractors and freelancers are also seeing the sense in forming their own limited companies.
You’d think lenders would realise how much of the market their outdated policies are ostracising. If the penny has dropped, it’s yet to roll down to branch level.
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. Through a specialist broker, who knows how to present your information to show your true earnings, this can be a good thing.
Some High Street lenders will use a combination of net profits before tax, plus your director’s salary. But this only works at underwriter level for the vast majority of lenders.
It does allow you to borrow much more than if they used drawings alone to calculate 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 is key
But please understand this, too. It’s these same underwriters who calculate how much you can borrow who also have the power to approve your mortgage.
It’s critical to your success that you approach them through a specialist who can present your earnings in the best light.
They often base affordability calculations on either your last fiscal year of accounts or an average of the past few years.
If your accounts have shown progressive growth, they often use the last year for working out affordability. In contrast, if your accounts have been erratic in recent years, they’ll consider your average income.
Through regulated specialists brokers, underwriters are working to bridge the gap. But until banks adopt wider acceptance of the self-employed, access to funds will remain as 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.
Author: John Yerou
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.