Ask anyone who works in home lending and they’ll tell you it’s more work for them if the loan applicant is self employed. If you’re a regular pay-as-you-earn (PAYE) employee, you can just give your lender payslips to demonstrate your income, but it’s a bit more complicated for self employed borrowers. It’s certainly not a deal breaker- plenty of business owners have little problem getting home loans, but it’s worth familiarising yourself with why it can be a bit more challenging.
At the end of the day, lenders just want to be satisfied the chances of you defaulting on your home or personal loan are low. It can sometimes be a bit more arduous for the self employed to prove this, but as long as you can do so, you shouldn’t have many problems. This can be contingent on providing your BAS (business activity statements), or proof of work and income.
While obtaining a home loan as a self-employed borrower may present extra challenges, it’s certainly not impossible. Here are some tips to enhance your chances of securing financing:
Keep your financial records organised
Maintain accurate and up-to-date financial records, including tax returns, profit and loss statements, bank statements, and business activity statements (BAS). Be prepared to provide documentation for at least two years, as this demonstrates a consistent income history to lenders. If you don’t have two years' worth of statements, you might need to consider alternative methods, explained further below.
Improve your credit score
A strong credit score enhances your chances of loan approval. Pay your bills on time, reduce existing debt, stay on top of your existing business borrowings, and don’t keep applying for loans - getting rejected a lot for loans can hurt your credit score. Regularly monitor your credit report and address any discrepancies promptly.
Increase your deposit
Offering a larger down payment can help mitigate the perceived risks associated with self-employment. A higher down payment not only reduces the loan amount but also demonstrates your commitment to the investment.
Consider alternative lenders
While many lenders offer home loans for self employed people, banks often have stricter lending criteria. Alternative lenders like credit unions or non bank lenders might be more flexible writing loans for self employed borrowers who might not meet standards at more traditional lending institutions. For example, non bank lenders aren’t guided by APRA’s serviceability buffer, so might have less stringent stress tests.
If you aren’t sure where to look, it could be worth consulting a mortgage broker. A broker is likely to know which lenders you are better off approaching if you are self employed.
Look into low-doc home loans
Low document home loans don’t require require as much paperwork as standard loans, useful for self-employed people who don’t have traditional means like payslips to demonstrate income. This could be particularly helpful for borrowers who have just begun working as a sole trader, and don’t have much of a track record. Lenders might be able to consider the borrowers prior employment history in the same industry if the loan is low document.
Lenders will still ask for details about your business and the associated income, which might include bank statements and tax returns, and an accountant’s letter confirming your ability to make the repayments.
Since low doc loans do not build as comprehensive a picture of your financial state to lenders, they are viewed as riskier, and therefore tend to attract higher interest rates. Only certain lenders offer low doc loans in Australia.
Why is it harder to get a loan if you’re self employed?
Lenders assess loan applications based on the borrower's ability to repay the debt. They want to figure out their current income, expenses and debts, and see if their financial situation will stretch to accommodate the new loan. This is fairly straightforward if the borrower is an employee, because they can just use their payslips to demonstrate their regular income.
For self employed borrowers however, being accepted for a home loan can be more complicated, for several reasons:
It’s harder for self employed people to demonstrate income
Unlike salaried employees who can provide payslips and employment contracts, self-employed borrowers rely on documents like company tax returns, personal tax returns, profit and loss statements, and bank statements. These documents require careful preparation and interpretation, and any inconsistencies can raise concerns for lenders.
Self employed people sometimes have inconsistent income
Self-employed borrowers often experience fluctuations in income, making it harder for lenders to assess their repayment capacity. Take a tax accountant, for example, who likely sees a surge in business from July when most regular people start to do their tax returns, while the rest of the year might be quieter. Irregular earnings can make it difficult to demonstrate a stable financial position, leading to increased scrutiny from lenders.
Self employed borrowers sometimes seem riskier
Lenders typically take the view that there’s a higher risk of a borrowers financial circumstances changing if they are self employed. Many self-employed people are in trades and construction, and in any given month, construction companies tend to top the list in the personal insolvency numbers.
Imagine two electricians: A works for the Department of Energy and B is a sole trader. They have roughly the same annual income, but one has his income guaranteed by his employment contract, while the other is reliant on clients coming in. Worse case scenario for electrician A is he loses his job, but even then he’s entitled to severance pay and typically four weeks' notice, while electrician B could see business drop off dramatically, and see his financial position change more suddenly.
This increased risk perception often translates into stricter lending criteria, including higher down payment requirements, higher interest rates, or more extensive documentation requests.