If you are self-employed, getting a home loan can be a bit complicated. Compared with PAYE, self-employed people need to provide more documentation to evidence your income.

At the time of writing, it’s March 2021. The end of the financial year is creeping up quickly. In this video, we will cover some tips on getting a home loan for self-employed people and some commonly asked questions about proof of income so that you can be well prepared.

Getting a mortgage when self-employed

Video Timeline

1. Banks now are requiring the latest financial statements. - 00:42

2. “How much should I pay myself?” - 03:11

3. How do banks assess financial statements for self-employed borrowers? - 04:10

4. Home loan Supporting documents required for self-employed borrowers. - 08:47

1. Banks now are requiring the latest financial statements.

Self-employed people carry out business activities on their own. If you have a trading company or work as a sole trader or in a partnership, you are self-employed.

Self-employed borrowers face the challenge of not being able to prove their income by simply presenting payslips from an employer. Instead, when applying for a home loan, you’ll need to provide some additional documents with your bank for them to determine your income.

One of the most important documents is the financial statements. This consist of the business’ profit and loss report, and balance sheet. Before COVID, the financial statements could be used for up to 18 months when applying for a home loan. In other words, the financial statements for the financial year of 2020 (1^st April 2019 – 31^st March 2020) could be used to prove your income until September 2021. 

However, considering that many New Zealand’s businesses have been impacted by the COVID pandemic, even though most businesses have recovered, banks still want to know up-to-date information about your business. This means you cannot wait till September to get your financial 2021 done because banks will require it as soon as financial year 2021 finishes.

At the time of writing (March 2021), we noticed that one of the banks has already started asking for the year-to-date financials. This is where self-employed borrowers get caught out. The financial year hasn't wrapped up yet, but the bank wants to see your financial situation as latest as possible. How tough it is for business owners to prove their income!

Our suggestion is, if you are looking to borrow in the next few months, , talk to your accountant as soon as the FY 2021 finished, and ask them to complete your financial statements as soon as possible to avoid delay of your application 

2. “How much should I pay myself?”

We often get asked by many business owners – “should I pay myself more so that I can borrow more for my home loan?” The short answer is not necessary. As the shareholder of the business, you can determine the amount of your salary/wage, but it doesn’t mean that your business can either afford it (say your salary is $100k, but your company has a loss of $20k), or your business may still have profit after paying your salary.

As the business shareholder, you may have both PAYE income and shareholder salary. When banks assess your income, they will not only include these incomes, but also any profit before tax. They will add them together. Therefore, you will still need to provide your financial statements so that banks can look at the overall picture. 

3. How do banks assess financial statements for self-employed borrowers? 

As we mentioned above, banks will look at your financial statements to determine your income. One of the most important figures are your business profit and your shareholders salary. However, they are not the only factors. At the end of the day, servicing ability comes from cashflow. Sometimes profit does not equity to cashflow. Therefore there are other things in your financial statements that often draw banks’ attention:

(1) Account receivable

When you make a sale, you may not be paid immediately. Instead, you provide your customer with payment term. Say you have an IT company and provide IT solution to your clients. You send out the invoices each time after your team deliver a service, and you allow your clients to pay the bills till next month. This means there is a sale, but your company won’t receive the payment until next month.

In the worst-case scenario, you delivered the service, but the clients never pay you, and then it turns into bad debt. That’s why the bank will review the account receivable to understand the amount and the age of the receivables. If your business has a large amount of account receivable or the age of the receivables is beyond certain terms, it indicates they may not be paid therefore reducing your business cashflow. .

(2) Business existing loans

Borrowing for purchasing business assets such as vehicles or equipment are typical loans that business may have. Banks needs to understand the loan details including total repayment amount of the principal and interest, and then deduct that figure from your servicing ability. This is because the bank wants to ensure that before you borrow more money, you will be still able to service your existing financial commitment. So, any existing debt under your business will affect your borrowing capacity.

(3) Excessive shareholder drawings

Are you keep drawing money from the company? If so, it may result in reduced cash flow in your business.

(4) The previous year financial statements will be reviewed as well

If your business has already traded for more than one year, banks will look at the previous year’s financial statements as well and see how the year-on-year comparison looks. They will compare some key figures, such as sales, gross profit, and fixed costs, to understand the changes. Usually these figures should be consistent. If not, they need to understand the underlying reasons.  

(5) Negative equity

Lastly, banks will look at the balance sheet and see if you have negative equity. Negative equity means you owe more than you own. If your business has negative equity, it may signal liquidity issue  of your business.

In short, banks will assess many factors in the financial statements to determine the income for self-employed borrowers. If you’re planning to apply for a home loan, it's important that you understand how the banks assess your income so that you can have more accurate picture of your borrowing capacity. 

4. Home loan Supporting documents required for self-employed borrowers.

(1) Last two year financial statements, as we mentioned above

(2) Bank statements for the last six months, so that banks can see how your business is tracking year to date, against the financial statements of previous years.

(3) GST return for the last six months for the same reasons above. 

(4) IR3 and IR4 - IR3 (the shareholder's personal tax summary) and IR4 (company tax summary) for the corresponding years of financial statements. At the time of writing (March 2021), you’ll be required to submit IR3 and IR4 for the year 2019 and 2020. Once we pass this March, both years of 2020 and 2021 will be required.

To sum up, it may not be easy to get a home loan when you’re self-employed as it requires much more documents to prove your income and a more in-depth assessment. That’s why we share this information with you close to the end of financial year so that you can prepare in advance and fast track your progress.

Prosperity Finance - Here to Help

Call us at 09 930 8999 to get in touch with Prosperity Finance team for professional advice and help with your application. If you’re preparing your financial statements, we’re happy to help you review even the draft version so that you can have a rough idea based on our indicative assessment and then finalize your financials.

Read more:

Getting a home loan when you’re self-employed during Covid-19, is it harder?

Top 5 reasons your home loan application is declined and what you need to avoid

Disclaimer: The content in this article are provided for general situation purpose only. To the extent that any such information, opinions, views and recommendations constitute advice, they do not take into account any person’s particular financial situation or goals and, accordingly, do not constitute personalised financial advice. We therefore recommend that you seek advice from your adviser before taking any action.