Self-Employed Home Loans: How Lenders Assess Sole Trader, Company and Trust Income

If you work for yourself, applying for a home loan feels different from the first page of the application. There’s no payslip to hand over. Instead, a lender has to work out a reliable personal income from your tax returns and business financials, and two lenders can look at exactly the same figures and arrive at very different numbers.

It’s common for business owners around Newcastle and the Hunter to get very different answers depending on where they apply. One lender’s assessment might support a loan of $650,000 and another’s $800,000, with nothing about the business having changed. The difference is lender policy.

This guide to self-employed home loans explains how lenders assess income for sole traders, companies and trusts, the adjustments that can lift your figure, what documents you’ll need, and how to prepare so your application shows your business at its real strength.

The Starting Point: Profit, Not Turnover

The most common misunderstanding I hear is that a lender will use the business’s turnover. It won’t. Lenders start from net profit, what’s left after business expenses, and then apply their own rules to it.

Those rules are where lenders differ most. Faced with two years of figures, a lender might:

• average the two years, which is the most common approach;
• use the lower year, especially if income has dropped; or
• use the most recent year, if income has grown and the growth is supported by up-to-date evidence such as recent BAS.

The same responsible lending laws apply whether you’re an employee or self-employed. A lender must verify your income and be satisfied the loan isn’t unsuitable for you. For business owners, that simply takes more paperwork. How your business is structured decides which paperwork, and how the income is read.

Sole Traders: Add-Backs Make the Difference

As a sole trader, your business profit appears as income on your personal tax return, so that’s where a lender starts. Most will ask for your last two years of personal tax returns and the matching ATO Notices of Assessment.

Lenders then make adjustments called add-backs. These are expenses you’ve claimed for tax that either didn’t take cash out of your pocket or won’t happen again. Each lender has its own list, but common add-backs include:

• Depreciation, an accounting entry for the declining value of equipment and vehicles, not a cash cost;
• one-off expenses that you can show won’t recur, such as a single legal bill or equipment repair;
• interest on business debts that the new loan will pay off; and
• voluntary super contributions above the compulsory amount.

Every add-back has to be supported by your financial statements or a letter from your accountant. Here’s how much they, and lender policy, can matter:

• A lender that averages the two years would use $126,000.
• A lender that takes the lower year would use $110,000.
• A lender that accepts the most recent year, backed by strong recent BAS, would use $142,000.

That’s a $32,000 difference in assessed income from the same tax returns, which can change your borrowing capacity by well over $100,000.

Companies: Salary, Dividends and Retained Profit

A company is a separate legal entity, so its profit isn’t automatically your income, even if you own every share. Lenders need to see how money gets from the company to you.

Most lenders start with what you’ve actually been paid: your director’s salary, shown on your income statement from the company, plus any dividends in your personal tax return.

Some lenders go further when you own and control the company. They’ll also count the company’s own profit, on the basis that you could pay it to yourself. Here’s how that plays out for a director who owns 100% of her company:

• Director’s salary: $100,000
• Company profit before tax, after paying her salary: $140,000
• Dividends paid to her from that profit: $50,000

A conservative lender counts the salary and dividends: $150,000.

A more flexible lender counts the salary plus the company’s pre-tax profit, $240,000 before tax, then allows for the company tax payable on the $140,000 when it works out what she can afford. It doesn’t also count the $50,000 of dividends, because those were paid out of that same profit. Counting both would count the money twice.

In practice, lenders run this across two years and apply their averaging rules, as in the sole trader example. Lenders that use company profit will also look at the company’s health: debts in its name, any money owed to the ATO, and whether the profit is really available or needed to keep the business running.

Trusts: Showing the Money Actually Reached You

Family trusts add another layer, because the trustee decides each year who receives the income. Lenders want to see a consistent pattern of distributions to you, usually over two years, using the trust’s tax returns and your personal returns.

The common sticking point is an unpaid present entitlement (UPE). That’s a distribution that’s been allocated to you on paper but left sitting in the trust. If the trust allocates you $140,000 but only $110,000 actually reaches your account, a cautious lender may only count the $110,000. A more flexible lender may accept the full $140,000, particularly if you control the trust and its accounts are strong.

If you’re planning to buy in the next year or two, it’s worth talking to your accountant about how distributions are made and paid, because it can directly affect what a lender will count.

Full Doc vs Low Doc Loans

Full doc loans are the standard, and usually the cheapest, option. Expect to provide:

• two years of personal tax returns and Notices of Assessment;
• two years of business financial statements (profit and loss, and balance sheet) and business or entity tax returns;
• an ABN that’s usually been registered for at least two years, though some lenders accept one, especially if you worked in the same industry before going out on your own; and
• recent business bank statements.

If your most recent tax return isn’t lodged yet, some lenders will work from the previous two years, depending on how far into the new financial year you’re applying.

Low doc loans are for borrowers who can’t provide full financials yet, for example because the business is new or the accounts are behind. Low doc doesn’t mean no doc. Since responsible lending laws came in, ASIC has made clear that lenders must still verify income, so expect to provide business bank statements, BAS, an accountant’s letter and a signed income declaration.

Low doc loans generally come with higher rates and fees, and usually need a larger deposit. Before going down that path, it’s worth checking whether a full doc lender with a more suitable policy would approve you. Plenty of business owners who are declined by one bank are approved by another, on standard terms, simply because its self-employed policy fits their structure better.

How to Prepare Before You Apply

1. Get your lodgements up to date. Tax returns, financial statements and BAS should all be current. Lenders won’t work with figures that aren’t lodged.
2. Talk to your accountant early. Minimising taxable income also minimises the income a lender sees. If you’re buying in the next year or so, discuss how that trade-off affects your borrowing before the financial year closes, not after.
3. Deal with any ATO debt. Lenders will ask. A tax debt on a payment plan you’re keeping to is viewed far more favourably than one that isn’t being managed.
4. Separate business and personal spending. Lenders read your bank statements to understand your living expenses. Clean, separate accounts make that much easier.
5. Reduce or close other credit. Lenders assess credit cards at their limit, not the balance. Our guide to what actually increases your borrowing power ranks the changes that make the biggest difference.
6. Choose the lender before you apply. Every application is recorded as an enquiry on your credit report, and several in a row can make the next lender more cautious (our guide to bad credit home loans explains how long enquiries stay on your file). It’s far better to match your structure to the right lender’s policy first.

Our borrowing power calculator will give you a starting estimate. Use your averaged adjusted income from above as your income figure.

Frequently Asked Questions

Get the Lender Right First

For self-employed borrowers, choosing the lender is often more important than choosing the rate. The right policy for your structure can mean a larger loan, standard pricing and a smoother approval, without changing anything about your business.

Want to know how lenders would read your figures? Call David on 0417 676 191 or get in touch via our contact form.

This article is general information only and does not take into account your objectives, financial situation or needs. Examples are simplified and illustrative only. Each lender applies its own income assessment policy, and nothing here is a promise that any application will be approved. Please speak with your accountant about tax matters and seek advice specific to your circumstances before acting.

Sources

• ASIC, Report 410: Review of ‘low doc’ home lending following the introduction of the responsible lending obligations, September 2014.
• ASIC, Regulatory Guide 209: Credit licensing: Responsible lending conduct.
• Australian Taxation Office, Business activity statements (BAS).
• Australian Taxation Office, Trusts.
• Moneysmart, Credit scores and credit reports.