You won’t need me to tell you that getting a mortgage is harder for a company director than it is for someone in a conventional job. Unfortunately, a lot of mainstream lenders simply don’t cater as well as they could do for business owners and other people categorised as self-employed. I fall into that bracket and I’m sure many people reading this article do, too.
The irony is that people who run companies or work for themselves can be less of a risk than someone on PAYE. After all, a company director will often derive an income from multiple clients or customers, which provides instant diversification. The employed, by contrast, are 100 per cent reliant on one company and one job, which is arguably a lot more ‘geared’ as they could lose that job tomorrow.
Anyway, that’s by the by. What I wanted to talk about today is something that occurs quite regularly when business owners do find a lender that will offer them a mortgage: they will not get a mortgage offer that reflects their true financial position, which can limit them in the properties they want to buy. Here’s why.
Draw what you need to live on
Most limited company directors, as many of you will know first-hand, only draw what they need to live on. They do this in the form of a salary (usually circa £8,000 for tax purposes) and dividends. Their real earnings are often a lot higher but, sensibly, they don’t take all the money they earn from their business, instead leaving it in the bank for cash flow reasons, to reinvest or for a rainy day.
The problem, though, is that most lenders will only lend based on the actual declared income that company directors pay themselves (as above, a mixture of salary and dividends). The snag with this is that it does not reflect the money they earn but which they leave in the company — their unpaid earnings, if you like.
For example, let’s say a company director pays herself an annual salary and dividends amounting to £50,000. Most lenders will apply a standard affordability calculation to this and typically it will enable her to borrow circa £240,000. That’s not a bad amount but in this scenario the company director would be stuck if she wanted to borrow £400,000.
Focus on net profits instead
Thankfully, all is not lost. There are some lenders out there that will base their underwriting decisions on the share of the net profits that company directors have in their business. In other words, rather than look purely at the salary and dividends that have been paid they will look at the real money being generated by the business, which will include money left in it. This makes a big difference.
After all, the net profit of the company director in the example given above might actually be £95,000 — £45,000 more than the income she paid herself. In this case, a lender that is prepared to look at net profits will lend the company director in the region of £446,000. Quite a lot more.
Crucially, this approach also means company directors who have their eyes set on a more expensive property don’t have to draw the extra funds out of their business and pay a hefty amount of tax on it. Instead, they can just prove it to the lender in their annual accounts and that will suffice.
Now I’m certainly not suggesting people take out loans bigger than they are comfortable with, but for company directors who pay themselves less than they are worth, being aware that some lenders will base their decisions on net profits rather than declared income is a useful thing to know — and can get them the house they have their heart set on.
Alastair McKee is managing director of One 77 Mortgages