Can a Mortgage Lender Use My Latest Year's Self-Employed Income?

If your self-employed income has increased, one of the first questions you may ask is:

"Will a mortgage lender use my latest year's figures, or will they average my previous years?"

There is no single answer that applies to every lender.

Different lenders can assess self-employed income in different ways.

That difference can become particularly important when the most recent trading year is considerably stronger than earlier years.

How Self-Employed Income Is Commonly Assessed

Depending upon the applicant's business structure, a lender may consider figures such as:

Sole trader

Typically based around taxable profit shown within HMRC documentation.

Partnership

Usually the applicant's relevant share of partnership profits.

Limited company director

Potential approaches can include:

• Salary
• Dividends
• Salary plus dividends
• Salary plus an appropriate share of company profit

The exact calculation depends upon lender criteria.

Latest Year Versus an Average

Consider this simple example:

Year 1: £35,000 Year 2: £55,000

An average of those years is:

£45,000

If one lender assesses the applicant using an average of £45,000 while another is prepared, subject to its criteria and evidence, to consider the latest figure of £55,000, affordability could look very different.

That does not mean the lender using £55,000 is being more generous.

It means it is applying a different underwriting methodology.

Why Would a Lender Use an Average?

Self-employed income can fluctuate.

A lender needs to decide whether the income supporting a mortgage is likely to continue.

A multi-year average can provide one way of smoothing out unusually strong or weak years.

For example:

Year 1: £60,000 Year 2: £35,000

A falling income trend is likely to raise different questions from:

Year 1: £35,000 Year 2: £60,000.

A lender will not normally ignore a significant decline simply because the average is higher than the latest year's figure.

When Might the Latest Year Receive More Attention?

Where the latest year is stronger, lenders may want to understand why.

Possible explanations might include:

• The business has matured.
• New contracts have been obtained.
• Trading conditions have improved.
• The applicant increased working hours.
• A business expansion has taken effect.
• Previous years were affected by an identifiable event.

The lender may then look for evidence that the improvement appears sustainable.

What Does "Sustainable" Mean?

There is no single document that proves future income.

An underwriter may consider the wider picture, potentially including:

• Trading history
• Company accounts
• HMRC figures
• Business bank statements
• Accountant information
• Current trading
• Nature of the business
• Recent changes

An unexplained sudden increase may be treated differently from a clear and established upward trend.

What Documents Might Be Required?

Depending upon business structure and lender, documentation may include:

• HMRC Tax Calculations
• Tax Year Overviews
• Finalised accounts
• Accountant's certificate
• Business bank statements
• Personal bank statements
• Payslips where a director receives PAYE salary

Requirements vary.

Providing the right figure on the wrong document can still delay underwriting.

What If I Only Have One Year's Accounts?

Some borrowers assume that fewer than two years' trading automatically means a mortgage is impossible.

That is too broad a conclusion.

Some lenders may consider shorter trading histories in appropriate circumstances, although the available options are typically more restricted and the complete case needs to be assessed.

Factors can include:

• Previous employment in the same industry
• Nature of the business
• Trading performance
• Deposit
• Credit history
• Income required
• Overall stability

Company Directors Need Extra Care

Limited company directors can create another layer of complexity.

Suppose a business generates healthy profits but the director deliberately draws a relatively modest salary and dividend.

A lender assessing only those personal drawings may produce very different affordability from a lender whose criteria permit consideration of an appropriate share of company profit.

The accounts have not changed.

The lender's assessment method has.

What If Your Latest Figures Are Significantly Better?

Before applying, it can be useful to establish:

1. Your latest finalised figures.
2. Previous-year figures.
3. The reason for any substantial increase.
4. The documentation available.
5. The mortgage amount required.
6. Which lenders' assessment methods may fit the circumstances.

This can avoid applying to a lender whose standard calculation will not produce the affordability required.