A New Window Opens for Self-Employed
Written on 7 February 2023 by
January 31st is not only renowned for being a significant date in a football fans diary across the country as transfer deadline day. Those that are self employed also have until this date to submit their tax return to the HMRC to avoid a fine of at least £100 for the previous financial year.
Despite this, a record 11.7 million customers submitted their tax returns on time, HM Revenue and Customs (HMRC) have revealed. On 31 January, 861,085 customers filed online to meet the deadline, some with minutes to spare. There were 36,767 customers who filed in the last hour before the deadline, but the peak hour for filing on the day was 16:00 and 16:59, when 68,462 customers submitted their tax return.
Mortgage search company Twenty7Tec saw a spike in demand for self-employed mortgages in February, as those who have submitted their returns can see what options are now available. Unlike employed who can use latest payslips or future employment as a way of determining affordability, self-employed are typically restricted by tax years.
Lenders will only use latest accounts / tax return that are no more than 18 months old. Of which lenders can use the latest years for affordability or take an average of the last two years. As a result, this means many need to wait until tax returns are done before establishing if they can borrow more from when they last reviewed.
Lenders also require tax calculation and tax year overviews. Tax year overviews show the tax has been paid which finalises the income declared on the tax calculation. As most will leave until the last minute to pay HMRC this often means only from February can you accurately assess affordability.
Are Self-Employed Treated Unfairly Compared to Employed?
Self-employed often get the wrong end of the stick, compared with those that are employed, when it comes to lender criteria and affordability.
Some lenders feel self-employed applicants pose a higher risk and as a result require further due diligence when it comes to their underwriting which often adds time to their standard SLAs and costs.
This means lenders, may reduce the LTV for those that have self-employed income. This was one of the key issues during the pandemic and months after as lenders had to get around the government grants and assessing if the business was profitable or not.
What Documents are Needed for Self-Employed?
Some lenders will require additional documents and commentary as part of their criteria and assessing affordability. These could include a breakdown of the impact the pandemic and Brexit had on the business as well as requesting details of the businesses’ current energy plans to ensure the costs remain affordable.
It’s not uncommon to request an accountant’s reference which will confirm the income for the previous year but also a forecast. This helps the lender balance the time and risk on the deal. Lenders may also request additional bank statements for both the business and personal accounts to ensure the income and drawings remain in line with previous years as per the accounts.
Adding to this if there’s a decline in the recent return, some lenders will use the income that’s lower from the last two years rather than taking an average.
Depending on if you’re a sole trader or a director in a limited company, lenders can typically use any of the following to assess income -
Directors of Limited Companies - salary and dividends, salary and net profits, net profits before or after corporation tax
Sole Traders - tax calculations and overviews. Lenders will then use either the latest years returns, using either average of the last two years. Or in the event that the account shows decline income, lenders will take an average of the last two years and use the lower.
What to Be Aware of When Applying for a Mortgage
Self-employed will be no stranger to requirements from lenders often requiring more information or a lender requesting commentary from an accountant on the strength of the business.
This time around, expect lenders to request further information on the impact of the inflation, energy, and other impacts to the sector of the business that have been affected.
Likewise, many businesses have seen profitability increases following the pandemic. Despite this being a positive some lenders may have restrictions on this.
For example, Suffolk Building society policy states ‘We will use the latest years self-employed figures if it’s lower than the previous year. If the latest year is higher, then we can only use this figure if there was less than a 20% increase. If the latest year has more than a 20% increase, then we will take an average of the last 2 years.
And for Nottingham Building society ‘We will always assess the latest full year's figures. If income/profit fluctuates by 15% or more, year on year, a suitably qualified accountant will need to provide a satisfactory explanation for the underwriter to consider.’
Getting a specialist mortgage broker – like John Charcol - who can assess the business but also find the right lender will always prove to be advisable.