For self-employed borrowers, working out borrowing capacity can be more complicated than looking at the salary going into your personal account.
A business owner might pay themselves $120,000 a year, while the business is producing significantly more profit behind that.
Another client might receive income through a company, trust distributions or a combination of different entities.
The challenge is that not every lender looks at that income the same way.
That is why self-employed borrowing capacity can vary quite a lot from one bank to another.
How Do Banks Assess Self-Employed Income?
For a standard PAYG employee, the starting point is usually fairly straightforward.
For someone who is self-employed, the lender may need to look at the wider business position.
Depending on the structure, that can include:
- Salary or director wages
- Company profit
- Trust distributions
- Retained earnings
- Business expenses and add-backs
- Ownership percentage
- Business debts
- How long the business has been trading
The important thing is understanding where the income actually sits and whether the lender is prepared to use it.
Your Salary May Only Tell Part of the Story
This comes up regularly with business owners.
You might pay yourself a salary of $120,000 because that suits the way your accountant has structured things.
But the company may also be making another $200,000 or $300,000 in profit.
If a lender only looks at the salary, the borrowing result may not reflect the strength of the business.
Some lenders may be prepared to look further into the company financials and use additional profit where the ownership and business position support it.
Others may take a more conservative approach.
That difference can materially change borrowing capacity.
Can a Bank Use Company Profit?
In some cases, yes.
But there are a few things the lender will usually want to understand first.
They may look at how much of the company you own, whether the profit is recurring, how much cash the business needs to retain for working capital, whether there are business debts and whether the company has been consistently profitable.
A business making a strong profit does not automatically mean every dollar of that profit can be added to your personal income.
The lender still needs to understand whether it is genuinely available to support the loan.
What About Retained Profit?
Retained profit is another area where lender policy can vary.
A business owner may deliberately leave profit inside the company rather than distribute all of it personally.
Some lenders may be prepared to consider part of that retained profit where the borrower has sufficient ownership and control over the business.
Others may not.
This is another reason I like to understand the full structure before deciding which lenders are worth looking at.
If we simply take a personal tax return or payslip at face value, we can miss a large part of the actual financial position.
Trust Distributions Can Be Treated Differently Too
Trust structures are common with self-employed clients.
You may receive income through a family trust or have business profits distributed between different beneficiaries.
The lender will want to understand where the income comes from, your connection to the trust and whether that income is likely to continue.
Some lenders are comfortable with trust income.
Others may want additional financial statements, tax returns or evidence of control before they will use it.
This is where two lenders looking at exactly the same client can come back with quite different answers.
Add-Backs Can Make a Difference
Business financials can also contain expenses that a lender may be prepared to add back when working out usable income.
Depending on the lender and the circumstances, this might include things such as depreciation, interest expenses or genuine one-off costs.
The key word is genuine.
Not every expense gets added back and not every lender treats them the same way.
That is why I prefer to go through the financials properly rather than just take the taxable profit figure and stop there.
Do You Always Need Two Years of Financials?
Not necessarily.
Two years of financials is still common, particularly where the lender wants to establish consistency.
But there are lenders that may consider one year of financials in the right circumstances.
That can be particularly useful where the business has grown strongly or where the older financial year no longer reflects the current position.
The lender will usually want to understand why the income has changed and whether the newer result is sustainable.
For example, if business profit has moved from $180,000 to $320,000, I would want to understand what drove that growth.
Was there a new contract?
More staff?
Higher margins?
An acquisition?
The stronger the explanation behind the numbers, the easier it is to present the position properly.
Reducing Tax and Maximising Borrowing Capacity Do Not Always Pull in the Same Direction
This is something I think self-employed clients should understand well before they need finance.
Your accountant may quite rightly be looking for legitimate ways to manage your tax position.
The problem is that lenders often rely on taxable income and business profit when assessing borrowing capacity.
So a structure that produces a lower taxable income can also reduce the income a lender is prepared to use.
That does not mean you should pay unnecessary tax just to qualify for a loan.
It means that if you are planning a property purchase or refinance in the next year or two, it is worth understanding how the lender is likely to assess the numbers before you get there.
Related: See Changed Your Business Structure? What It Can Mean for Your Borrowing Capacity.
The Lender Can Matter More for Self-Employed Borrowers
For a straightforward PAYG borrower, there may be a fairly tight group of lenders producing similar results.
For self-employed clients, the gap can be much wider.
One lender may be comfortable using company profit.
Another may not.
One may accept one year of financials.
Another may insist on two.
One may take a sensible view of retained profit or trust income.
Another may assess the exact same structure much more conservatively.
This is where selecting the right lender becomes more important than simply starting with whoever has the lowest advertised rate.
What If Your Financials Are Not Ready Yet?
Sometimes the business is trading well, but the latest tax returns or financial statements are not complete.
That does not always mean the lending has to wait.
Depending on the situation, an Alt Doc lender may be able to assess income using other evidence such as BAS, business bank statements or an accountant’s declaration.
That can be useful where the business position is strong but the standard full-doc process does not fit the timing.
It may also be something we use as a shorter-term solution, then review again once the full financials are available and the numbers support a mainstream refinance.
Related: See Alt Doc Lending for Self-Employed Borrowers: When Can It Be Useful?
Start With the Business, Not the Application
For a self-employed client, I generally want to understand the business before we talk about which bank to use.
How is the business structured?
Who owns it?
Where does the profit sit?
How much do you pay yourself?
Are there trusts involved?
Are the latest financials complete?
Has the business grown or changed recently?
Once we understand that, we can work out which lenders are actually likely to assess the position properly.
That is usually a much better starting point than submitting an application and trying to explain the structure afterwards.
Self-Employed and Thinking About Your Next Property?
If you are self-employed and want to understand what a lender is likely to use as income, we can go through the business structure, financials and the way the income flows through to you.
Book a strategy call with me and we can look at your borrowing capacity, which lenders are likely to suit the position and what information we need before you start making plans around the property.
