Operators of small businesses make an important contribution to our economy. They are often more financially secure and have a much greater potential to scale their income than people who work as employees.
However, self employed people often face hurdles when applying for a loan because, unlike employees, they don’t receive a regular salary and therefore do not fit lenders’ standard credit assessment criteria.
The three main obstacles that a self employed loan applicant faces are;
1. proving income,
2. demonstrating a capacity to repay the loan on time, and
3. being in a good net asset position.
In applying for a fully documented loan (full doc) it can be difficult for the self employed to prove their true income, as our taxation system allows them to offset their expenditure against their income and only declare their profit once a year.
Many lenders will require evidence of income in the form of certified financial statements which include balance sheet and profit and loss statements, as well as certified taxation returns for the borrower(s) and their business and/or company.
Lenders want to see at least the previous two financial years of good profit and increasing income. Self employed applicants often have erratic revenue, may be vulnerable to economic decline, may incur rising operating expenses and be affected by changes in market movements – so they need to demonstrate their income over a longer period of time than an employee is required to prove.
Capacity to repay
In conjunction with assessing your income, lenders need, and have an obligation, to verify your ability to service the loan as well as other liabilities you may have. In other words, the lender needs to make sure that you can meet the prescribed loan repayments for all your credit facilities.
In addition to providing the financials mentioned previously, you may be required to supply interim financials and/or a statement of income signed by your accountant to support your loan application.
The lender may also require information about your business such as the length of time it has been operating and the specific nature of the business.
The longer you have been self employed in the same business, the better it is for your application. If you have changed business, but still work in the same industry, your application may still be considered providing it is supported by relevant financials for each business. But if you have been self employed across multiple businesses and industries within a short period of time, it’s highly likely that you will need to wait until you have financials for at least two years in the same business before you are eligible to qualify for a home loan.
As well as being able to demonstrate sufficient income to repay the new loan, lenders will look at the strength of your asset position. If your business generates a good profit, but you own no assets of significant value, the lender will question what you do with your money. They may consider that you are not sufficiently disciplined to develop an asset base.
When you purchase a property, you need to have sufficient funds available to contribute to the deposit and cover the purchase costs, for example, mortgage and/or transfer stamp duty. An application which shows a consistently good savings history will generally be considered more favourably than one where there is no evidence of savings. Alternatively, savings in the form of payments to an existing loan may be demonstrated by equity in a property you already own.
Other loan options
If you will have difficulty in meeting the assessment requirements for a full doc loan outlined above, then a Low Documentation (Low Doc) loan may be a more suitable option.
Low doc applicants need to fully disclose their assets and liabilities and self-declare their income by signing an ‘Income’ or ‘Borrower’ Declaration form. The Australian Taxation Office has data matching capabilities and is able to detect inconsistencies in declared income and reported taxable income.
There are also requirements in relation to ABN and GST registration. A self-employed applicant must have a current ABN which has been registered for at least two years and the ABN must be GST registered, also for at least two years, although there are exceptions to this period of time with some lenders.
If you are self employed and considering taking out a loan to buy an investment property or restructure your loan portfolio, please give us a call at Metropole Finance –on 1300 782 524 – we specialize in helping self employed and professional investors or click here now to register for an obligation free consultation or just a quick phone chat.
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