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The most significant difference between a self-employed and salaried person applying for a home loan is the lender’s visibility on the borrower’s ability to afford the mortgage. It is the legal responsibility of the lender to ensure that a borrower can afford the home-loan the lender issues. While in case of a salaried employee payslips provide reliable and convenient visibility into a borrower’s financial stability, self-employed professionals need to give a lot more documentation to establish affordability. Here’s a quick look at the challenges and some suggested tips for self-employed professionals.
- Income Proof: Lenders approach income calculations in different ways. Most lenders need two years of income tax returns, but many also take a detailed look at business activity to assess a borrower’s financial position. Here are some methods lenders use
- Most recent income visible on income tax returns
- Lowest income in the past two years as shown in the borrower’s income tax returns
- Average of income earned over the past two years
- 120% of the lowest yearly income over the past two years
Also, some lenders consider extra superannuation contributions and tax refunds while many don’t. In a nutshell, in addition to a very heterogeneous approach to income calculations, as a self-employed person, you would need to provide a lot more paperwork and documentation.
- Industry: Lenders also consider the industry the self-employed borrower is working in. People employed in high-risk industries like international travel and tourism will find it harder to secure a loan.
- Loan Amount: A lot of times, self-employed professionals aren’t able to secure home-loans that match their income. Most lenders look at the last two years of income for self-employed. So, if you’ve seen a recent spike in income or boost in business and the revenue increase is less than two years old, it is unlikely that you would be able to factor this into the loan amount you wish to secure.
- Two-year income window: As mentioned earlier, lenders usually look at income over the last two years. If you have been self-employed for less than two years or have switched to a new industry less than two years ago, it will be harder for you to secure a loan.
- Don’t gravitate towards a low doc loan without a thorough check: A low documentation loan, as the name suggests, is a loan that requires lesser documentation but typically has a higher interest rate. Seek professional advice to check your eligibility for a regular home-loan before considering a low documentation loan. Despite being self-employed with the right prep, you may secure a regular loan.
- Avoid Business loans: A lot of small business owners may be tempted to seek out a loan from the lender that caters to their business financing needs. While it is okay to use such a loan for your business expenses, avoid it for a residential purchase as the interest rates of a ‘business loan’ could be significantly higher.
- Prep well for the documentation: As discussed earlier, the processing time and documentation for a self-employed professional is a lot higher. To make things easier, be prepared with the required documentation in advance.
- Make your past two-year income tax returns readily available.
- Each lender has a different approach to reading tax returns and calculating income, make sure you understand the approach your lender is taking and collect all necessary information.
- Have a clear understanding of how your business works – revenue, credit and expenses. Collect all details of business add-backs like-
- Vehicle expenses
- Interest for closed loans you are no longer paying
- Additional super contributions
- Non-recurring and non-cash expenses
- Keep debt under control: With lenders getting a lot more cautious in dispensing loans as a self-employed professional, your living expenses are subject to a lot more scrutiny as compared to a salaried borrower. Keep a tab on your expenses and control online and credit card spending.
- Seek professional advice: With the post-COVID mortgage landscape changing rapidly, it is best to seek professional advice from a mortgage broker who will not just help you to zero in on the right type of loan but also the lender.