Mortgage-lending for the Self-Employed and Small Business Owners

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Whilst the financial crisis undoubtedly took its toll on lending, a decade of historically low interest rates, combined with a number of government initiatives to boost home ownership, has meant that demand for mortgages from the self-employed and contract workers has continued to rise.

According to the Council of Mortgage Lenders, 120,000 new loans were taken out by the self-employed in 2016, an 11% increase on the previous year whilst, according to Paragon, borrowers who work for themselves accounted for 21% of all specialist mortgage applications in Q4 2017.

However, following the abolition of self-cert loans and 125 percent loan to value mortgages, the self-employed and small business owners have regularly faced additional hurdles when it comes to borrowing; historically they have been required to produce at least two years of audited accounts to qualify for a mortgage, with many lenders far less willing to take what they consider as a ‘risk’ on those with a ‘non-standard’ income.

The Mortgage Review of 2014 brought further complications into the mix, with standardised stress tests designed to test whether borrowers could afford to pay a mortgage both today and if rates were to be 3% higher in the future. And whilst interest rates have increased, they are still at historically low rates, which has prompted some industry experts to question whether stress-testing rules need to be revised.

John Phillips, Operations Director for Just Mortgages Group, said: “Put simply, mortgage stress tests are just too tough. They are acting as barriers to many people and are continuing to lock many out of the market altogether, including first-time buyers. Carrying out these tests on customers when we don’t know what the future holds just doesn’t make sense.”

Phillips also highlights that shifts in economic circumstances and changes to lending rules are making it more difficult for lenders too.

“Lenders are being continually faced with a raft of changes that are making innovation almost impossible,” he says. “This is certainly true in terms of mortgages for the self-employed. The regulator must therefore make it easier for lenders to offer new and innovative products in order to cater for the changing needs of the borrower.”

Restrictive rules aside, with nearly one in five workers either self-employed or on a fixed-term or zero hours contract, the growth in the so-called ‘gig economy’ is causing many lenders to reassess their lending criteria and to launch new products onto the market. The big banks, for example, will lend up to 85% of a property’s value to self-employed or contract workers who qualify for a standard loan. But here lyeth the obstacle – what does it take to ‘qualify’?

Whilst self-employed borrowers should, in theory, have access to the same range of mortgage products as anyone else, mortgage brokers will still apply different rules depending on whether you are self-employed, a partner or director of a limited company. Below are the key differences:

Self-employed
A lender will typically class you as self-employed if you own more than a certain percentage of a business – typically 20 or 25 percent. You will need to prove the income that you are declaring, which is usually done by supplying the accounts of business, either via self-assessment using form SA302 from HMRC or via an accountant’s reference prepared by a qualified accountant.

Lenders will assess you on your profits and may want proof that similar income is due in years to come.

Partnerships
Partners will generally be treated the same a self-employed borrowers and lenders will typically look at your share of the net profit when calculating your borrowing potential.

Directors of Limited Companies
As a director of a limited company it’s likely that your income will be made up of a combination of basic salary and dividend payments. Both elements of income will usually be considered however how lenders treat it can depend on your share of ownership.

As mentioned above, as part of the process of assessing your borrowing levels, lenders use a range of stress tests to calculate affordability. This can be particularly difficult for small business owners, whose monthly income is rarely set at a fixed amount.

James Cotton of London and Country explains: “If you’re self-employed, your income may fluctuate quite considerably from one month to the next or from year to year so estimating a typical monthly budget may be difficult……if this is the case then lenders will often take the average of the last three years’ income rather than just the latest year. However, if your latest year’s income is lower than previous years, this may be the figure that a lender will base affordability on.”

Cotton also explains that as a director of a limited company, some business owners may have profits that they choose to retain in the business as well as those that they take out and that some lenders may be able to consider some of those retained profits when making their calculations.

What else is being done to help?
Following a petition launched by renter Jamie Pogson, which attracted more than 146,000 signatures, there have been discussions about the possible use of rental payment history as means of testing a borrower’s ability to meet mortgage payments. Whilst nothing official has been set in motion, it is hoped that the Government’s past willingness to address homeownership affordability issues, such as the launch of shared ownership schemes, will encourage them to consider rental payment history as another option.

That said, the majority of new initiatives, including the Help to Buy ISA and the Lifetime ISA, have been targeted at first-time buyers, and there is a call for other sectors to receive some assistance.

Jonathan Harris, Director of mortgage broker Anderson Harris says: “It would be good to see more innovation in the future to help other segments of the market that may have struggled to get funding, such as self-employed and older borrowers.” London Money director Martin Stewart agrees: “We need to address the fact that debt is going to be carried from this generation to the next, way beyond the age of 70. We need a hybrid solution that can fill the gap between a traditional mortgage and equity release.”

Other points to consider:
• Some lenders may request a larger deposit as a condition of lending to self-employed borrowers.
• Nearly all lenders will take self-employed earnings into account if you can produce a SA302 form
• Retaining too much profit in your business could hinder your borrowing potential; paying a fair dividend against the profit made each year should help
• If you’re thinking of changing your company status, say from a sole trader to a limited company, prior to applying for a mortgage, check the implications of doing as it could hinder your application
• A good credit rating is a must in order to have access to the best rates

If you would like some help and advice sourcing your next mortgage*, please contact your Finura Partners adviser.

*Your home may be repossessed if you do not keep up repayments on your mortgage.

Articles on this website are offered only for general informational and educational purposes. They are not offered as and do not constitute financial advice. You should not act or rely on any information contained in this website without first seeking advice from a professional.

Sources: https://www.telegraph.co.uk/money/jessica-investigates/self-employed-can-get-mortgage/
https://www.yourmoney.com/mortgages/self-employed-ensure-smooth-mortgage-application-process/
https://www.theguardian.com/money/2018/feb/17/self-employed-mortgages-home-loans
https://www.thisismoney.co.uk/money/smallbusiness/article-2310556/How-mortgage-self-employed.html
https://www.yourmortgage.co.uk/specialist-mortgages/self-employed-account-for-one-in-five-specialist-mortgage-cases/

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