Self-employed mortgage affordability
It’s now a legal obligation for lenders to check if you can afford a mortgage repayment if interest rates were to increase by 6-7% and to multiply your income by 4-5 times to assess your maximum borrowing amount. Usually, lenders accept 100% of basic salary but many differ on other earned incomes that they’ll consider. For example, some lenders only accept 50% of overtime.
Lenders use income multipliers to limit the amount you can borrow so, for lending up to £175k, or anything over 85% loan-to-value (LTV), then the mortgage amount should be capped at 4.5x your income. If it’s over £175k, then it should be capped at 5x your income.
There are also other rules to consider, such as if you are applying for a Help to Buy mortgage, there is a cap of 4.4x and a cap of 4x for loans above 85% LTV if your income is less than £50k. You won’t get a completely accurate figure until you apply for a mortgage, but using the rules above, you, or a lender/broker, can get a rough estimate.
What if I’m self-employed?
If you’re self-employed, most lenders calculate income on a director’s salary plus the dividend income drawn over the year. They usually take the average over the last 2-3 years, depending on the lender and length of trading time for the business. If it’s a new business, there are specialist lenders that will use the most recent year’s trading figures. It’s also possible that some lenders will use your SA302 self-assessment returns to look at your income, which can be beneficial if you have recently changed your trading style from sole trader to a limited company.
What about my retained profits?
Most self-employed directors draw a minimum wage up to the tax-free allowance and only draw a small portion of the profits as dividends. However, most lenders only look at the salary and dividends drawn from the business, not the retained profit, meaning they won’t lend the amount that you could afford quite easily. Fortunately, specialist lenders that focus on this do exist, and will look at the overall profitability of the business and will assess your income by looking at the share of net profit either before or after tax plus salary.
I’ve only recently started as self-employed...
Regardless of your business’s legal status, most high-street lenders will want 2-3 years’ worth of trading accounts. However, if you have your first full year’s trading and you can prove that your business is profitable, and your income can be evidence through your accounts or your SA302, then you could still get your application accepted. The income multipliers for new businesses are generally the same as they are for everyone else – between 4-5x your income.
However, the number of lenders looking at businesses that have only been trading for a year is shrinking, making it more difficult to get a large mortgage, so it’s important that you speak to a broker who has access to a wide panel of lenders. Fortunately, there are also specialist lenders that look at this sort of self-employed application.
For advice on the income multiplier works, especially relating to your own circumstances, speak to one of our expert mortgage advisers, who will be able to help you with the next steps.