Getting a home loan when you’re self-employed

Lenders often shy away from those who work for themselves. The self-employed don’t always offer the financial stability a lender looks for in a borrower and as such, as a self-employed person applying for a home loan, you’ll need to provide tax returns and letters from your accountant before most lenders will even consider you.

Even then, many lenders ask that you’ve worked for yourself successfully for at least two years. It all comes down to risk. A lot of lenders don’t like lending to self-employed people because there’s less income certainty. A bad few months for you may mean that you can’t make your repayments.

But these days more and more Australians are working for themselves, either running small businesses or freelancing across various fields and industries.

So, if you're self employed and thinking of applying for a home loan, here's what you need to know.

Applying for a home loan

Less than two years of self-employment experience

If you’ve been self-employed for less than two years, you can still get a home loan, but there are some strings attached. Of the lenders that offer loans to people with less than two years’ of self-employment history, most ask that you have worked in your industry for longer than two years.

For example, if you’re a self-employed electrician, a lender will want to see that you’ve worked for an electrical company earlier in your career. If you’re a freelance designer, lenders will want to see that you were employed as a designer at some point in your career.

• Tip: Keep old payslips and get references from your former employers. This can help you speed up the home loan process.

What if I have less than one year’s experience?

Unfortunately, this further limits your options. Major lenders and banks won’t offer any home loan products to you if you’ve worked for yourself for less than one year. They need to see proof of income from your tax returns and other documentation.

However, some speciality lenders may take the wage from your last traditional job into account. They’re thinking that if your business fails, you can always go back to a job that earns similar money to what you earned before.

• Tip: Speak to one of our home loan advisers to find out about your options.

How will a lender work out my income?

Lenders ask for your old tax returns because they offer a guideline for how much you earn. They try to figure out how much the business may grow and whether your income will be stable for a long period of time. The technique for this varies depending on the lender. Some will base their estimates on your lowest income figure, whereas others may use your most recent tax return. Others still may take your entire self-employment history into account and create an average income figure.

The technique used will affect your home loan application. As a result, you need to figure out how different lenders look at self-employed people. After that, you should consider which technique would suit your situation.

believes the banking royal commission will pose even more hurdles for small business owners looking to get a home loan.

Kaleb had a client recently who was a shareholder in an SME and who derived quite a large salary from that company. “The company had consistently made $1m annually over the last 10 years,” he says, adding thereby 30% of the company’s distributable profits also belonged to this client.

“But one of the big 4 said they wouldn’t take the 30% distributable profit into account because they said my client didn’t have a controlling interest (i.e. more than 50%). The other shareholders could get together and say the profits are not yet available for distribution.

“That’s never going to happen,” he says, but adds lenders are asking a lot more questions.

“Banks and traditional institutions are tailored towards PAYG [Pay As You Go] salaried wage earners and they don’t understand how small business works, the financials, depreciation etc. They are just used to someone on a PAYG payment summary and not trained in small business.”

Lenders also track industry data. As a result, your chances of getting a loan may fall if the lender knows that defaults from people in your industry have risen in recent years.

Let’s delve a little further.

What are lenders looking for in tax returns?

Every tax return you send to a lender must come with a notice of assessment. Your lender will check the signatures and certification to ensure everything matches up. Doing this ensures the tax returns you send to a lender match those you’ve submitted to the Australian Taxation Office (ATO).

After that, your lender will start looking at your returns in more detail. Some lenders ask for more documentation depending on your status. For example, some lenders want different documents from companies than they do from sole traders.

Finally, there are add-backs. These are any strange expenses that your lender recognises as not being a part of your regular business. Some will add these expenditures back onto your income to create a more realistic figure. Others may not.

An add-back is any expenditure that your lender recognises as something other than an ongoing expense. Such expenditures can reduce your taxable income. However, this doesn’t mean that they lower your actual income.

Examples of potential add-backs include:

• Additional contributions you make to a superannuation fund
• Depreciation on your taxable assets
• Any one-off expenses that don’t show up again in other tax returns
• Any net profits you retain in a company. These are known as Net Profits Before Tax
• The interest you pay on any business or personal loans. Some lenders will assume that you have deducted this interest from your tax returns
• Any income you distribute to others via a trust. You may need to provide additional documentation for this, such as a letter to confirm that your trust members don’t rely on the income they receive from the trust
• The depreciation you can claim back on assets, maintenance, and management of a rental property. Some lenders also take negative gearing into account.
  
  Your company car may also play a part. Lenders don’t consider company cars as add-backs in the traditional sense. However, they may assume your income is between $3,000 and $6,000 higher than your tax returns show if you have a company car.
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