An Introduction to Securing a Mortgage When Self-Employed

Lenders typically view self-employed borrowers as higher risk compared to those in employment, mainly due to fluctuating incomes and the potential lack of job security. However, securing a mortgage while being self-employed is quite possible. You should be able to get approval for a mortgage that suits your needs with careful planning and the right documentation.  

1. Understanding What "Self-Employed" Means to Lenders

From a mortgage lender’s perspective, you are considered self-employed if you own more than 20-25% of a business from which you earn your primary income. This could mean you are a sole trader, a partner in a business or a director of a limited company. The key factor here is that you are responsible for generating your own income, as opposed to receiving a fixed salary from an employer.

Lenders assess the financial stability of self-employed applicants differently from those who are employed because the income of self-employed workers can vary significantly from year to year. Understanding how lenders view your financial situation is crucial to securing a mortgage when you are self-employed.

2. How Lenders Assess Self-Employed Applicants

a) Proof of Income

The most important aspect of your mortgage application as a self-employed person is proving that you have a sufficient and reliable income. Lenders will typically require at least two to three years of accounts and tax returns to demonstrate that your income is stable.

Most lenders will use your average earnings over the past two or three years to assess affordability, although some will look at the most recent year if your earnings have been growing consistently. To ensure your accounts are reliable, it is recommended that they are prepared by a chartered accountant, as lenders prefer professionally prepared financial records.

b) Tax Documentation (SA302)

One of the key documents you will need is your SA302 tax calculation for the last few years, which you can obtain from HMRC. This document summarises your total income and the tax you have paid. You will typically need to provide two to three years' worth of SA302 forms, along with the corresponding tax year overviews. Many lenders request these documents alongside accounts.

c) Business Accounts

For those running a limited company, lenders might want to look at your company’s business accounts, specifically to check the retained profits, and directors’ salaries and dividends. Lenders often use the combined amount of salary and dividends to calculate your affordability. In cases where the business retains significant profits, some lenders may also take this into consideration.

3. Boosting Your Chances of Getting a Mortgage

a) Build a Solid Credit History

Your credit score also plays a crucial role in mortgage approval, whether or not you are self-employed. Lenders want to see that you have handled debt responsibly in the past. To boost your credit score:

• Register on the electoral roll: This is a quick way to boost your score and prove your residence.

• Pay bills on time: Utility bills, credit card payments and other loans should be paid promptly.

• Avoid taking out new credit: Before applying for a mortgage, try to avoid taking on new debts that may impact your affordability.

b) Save for a Larger Deposit

One of the best ways to improve your chances of securing a mortgage is by putting down a larger deposit. Most self-employed borrowers aim for at least a 10% deposit, but putting down 20% or more can increase your chances of mortgage approval and may even help secure a better interest rate. Larger deposits lower the loan-to-value (LTV) ratio, reducing the lender’s risk. This makes them more inclined to approve your application.

c) Reduce Your Debt-to-Income Ratio

Lenders assess your debt-to-income (DTI) ratio, which is the amount of your monthly income that goes toward debt repayments. A high DTI ratio can be a red flag to lenders, as it indicates that you could struggle to meet your mortgage payments.

To improve your DTI ratio, focus on paying down existing debts before applying for a mortgage. This will free up more of your income and make your application more attractive.

d) Prepare a Bigger Picture of Your Business

Lenders want to know that your business is stable and profitable. Besides providing your financial accounts, it is a good idea to demonstrate any factors that make your business more secure. For instance, you might want to show evidence of future contracts or retainers, long term clients and steady growth. The more information you can provide that shows your business is stable and growing, the more confidence lenders will have in your ability to repay the mortgage.

4. Self-Employed Mortgage Lenders: Who to Choose?

When looking for a mortgage, you will find that some lenders are more self-employed-friendly than others. While high street banks can offer competitive rates, their criteria might be more rigid. Specialist lenders, on the other hand, are sometimes more flexible with self-employed borrowers, though their mortgage interest rates may be slightly higher.

It is worth considering speaking to a mortgage broker who specialises in self-employed mortgages. Brokers have in-depth knowledge of the market and can match you with lenders who are more likely to approve your application. A broker can also negotiate better terms and help you with filling out the application form and the documentation required.

5. Overcoming Common Challenges

a) Fluctuating Income

One of the main challenges for self-employed borrowers is fluctuating income. Lenders want to see a stable financial picture and fluctuating income can make it harder for them to assess your affordability. To mitigate this, try to smooth out your income by reducing expenses or saving a portion of profits during high-earning months to cover lean periods.

Alternatively, some lenders may accept applications from those with just one year of accounts, provided the business has been achieving strong growth and profitability. It is worth discussing your situation with a mortgage broker.

b) New Business Challenges

If you have been self-employed for less than two years, you might face additional challenges. However, some lenders are willing to consider mortgages for those with just one year of accounts. You will probably need to demonstrate that you have a strong track record and may need to provide additional evidence such as business plans and forecasts.

In cases where you are newly self-employed but have previously worked in the same industry, lenders may take this into account and consider your experience in assessing your application.

c) Complex Business Structures

If your business structure is complex, such as if you are operating a partnership or you are a freelancer with multiple income streams, be prepared to explain your set up clearly. Lenders like transparency, so having a clear explanation of your income sources can improve your chances.

6. Preparing for Your Mortgage Application

The better prepared you are, the smoother the mortgage application process will be. As a self-employed borrower, it is essential to:

• Gather all the necessary financial documents: two to three years of accounts, tax returns, SA302s, annual overviews and so on.

• Ensure your credit history is in good order.

• Have a clear understanding of your business finances and future growth prospects.

• Save as much as you can for a deposit.

• Consider consulting a mortgage broker who specialises in self-employed clients.

Conclusion

While getting a mortgage as a self-employed individual can be more challenging than for those in traditional employment, it is by no means impossible. You can increase your chances of securing a mortgage that suits your needs with careful preparation, thorough documentation and a proactive approach. Remember that each lender has their own criteria, so it is important to shop around or use a specialist broker to find the best deal.

FAQs:

1. How many years of accounts do I need to provide as a self-employed applicant?

Most mortgage lenders will usually require at least two to three years of accounts, together with tax returns, SA302s and annual overviews, to assess your income. However, some lenders may accept just one year of accounts if your business has achieved strong growth and profitability. It is always best to aim for two to three years of solid records.

2. Can I still get a mortgage if my income fluctuates?

Yes, you can still get a mortgage if your income fluctuates, but it may make the process slightly more challenging. Lenders typically look at your average earnings over the past two or three years to assess your affordability. Some lenders may also take a more flexible approach if you can demonstrate consistent growth in your income.

3. What documents do I need to provide as a self-employed borrower?

To apply for a mortgage, you will need to provide documents that prove your income, including:

• SA302 forms from HMRC for the last two to three years.

• Tax year overviews.

• Full business accounts prepared by a chartered accountant. Some lenders may also request additional documentation, such as bank statements and business plans, if you are newly self-employed.

4. How does my credit score affect my mortgage application as a self-employed individual?

Your credit score is crucial, whether you are self-employed. Lenders will assess your creditworthiness to ensure you can manage debt responsibly. A higher credit score increases your chances of securing a mortgage and getting better rates. To improve your score, pay all bills on time, reduce debt and avoid applying for new credit before submitting your mortgage application.

5. Do all lenders offer mortgages to self-employed individuals?

No, not all lenders have the same criteria for self-employed applicants. High street banks may have stricter requirements, while specialist lenders are often more flexible with self-employed borrowers. Working with a mortgage broker who specialises in self-employed mortgages can help you find the right lender for your situation.

6. Can I use retained profits from my business to secure a mortgage?

Yes, if you are a director and shareholder of a limited company, some lenders may consider retained profits in addition to your salary and dividends when assessing your income. However, not all lenders take this into account, so it is important to check with your lender or work with a mortgage broker who understands how to present your business income effectively.

Sources:

Getting a mortgage while self-employed | Lloyds Bank

Getting a mortgage when self-employed | NatWest

How do you get a self-employed mortgage? | Experian