In the UK, mortgage lenders generally use gross income to assess self employed people and individuals’ borrowing capacity. For self-employed applicants, there is often some confusion around gross and net pay; hopefully, this article will help with that. Understanding this key difference is essential for prospective borrowers in preparing for a mortgage application.
Mortgage Lenders In The UK
The UK mortgage market is notably diverse and vibrant, offering an extensive range of products that cater to a wide array of financial situations.
This market encompasses traditional high-street banks, which often provide more conventional mortgage products, and specialist lenders, who make mortgage deals that are typically more flexible and cater to unique or complex financial circumstances. The vast choices available in the market mean that almost every borrower, regardless of their financial background or requirements, can find a suitable mortgage product.
Income assessment is a pivotal element in the mortgage application process. This evaluation includes a thorough analysis of the type and stability of the applicant’s income, which plays a crucial role for most lenders in determining their eligibility and the mortgage terms. Lenders look for consistency and reliability in income, which indicates a borrower’s ability to meet repayment obligations.
Understanding Income Types
When it comes to income types, understanding the distinction between gross and net income is essential for prospective borrowers. Gross income represents an individual’s total income before any deductions are made. This includes all sources of income such as wages, overtime pay, bonuses, and other additional earnings. Gross income offers lenders a broad perspective of an individual’s financial strength and earning capacity, which is critical in assessing their potential to manage mortgage repayments.
On the other hand, net income refers to the amount an individual actually takes home after all deductions, such as taxes, pension contributions, and other mandatory expenses, have been subtracted from the gross income. It reflects the disposable income available to the individual for their everyday expenses, including mortgage repayments. Net income is a key indicator of an individual’s day-to-day financial health and ability to manage financial commitments.
The main difference lies in their calculation. Gross income gives a broader view of financial capability, whereas net income reflects actual disposable income.
Self-Employed Status In Mortgage Applications
When it comes to applying for self-employed mortgages in the UK, lenders assess individuals differently based on their business structure. The primary categories include contractors, sole traders, and limited company directors. Each group presents a unique set of financial statements and income streams, influencing how lenders calculate their borrowing capacity.
If you have less than 1 years accounts, we recommend checking out our “Guide To Mortgages For Self Employed With 1 Years Accounts”.
Contractors and Self-Employed Professionals
Contractors, especially those operating through limited companies, often have a distinct advantage in the mortgage application process.
Lenders may assess their income based on their contract value, akin to an employed person’s salary, rather than their taxable income. For example, a contractor earning £500 per day with a total annual income channelled through a limited company might be able to obtain a higher mortgage.
This is because the contractor’s taxable income appears lower after offsetting expenses such as equipment, travel, and office costs. Still, some lenders allow us to use their gross pay, providing a much more favourable borrowing capacity.
Sole Traders And Limited Company Directors
For sole traders, lenders typically look at net profits before deductions of tax and National Insurance, averaged over the last two years. This approach gives lenders an insight into the sustainable income level of the sole trader. There are some lenders that will accept the latest years net profits, which can enhance the amount they will be prepared to lend.
Limited company directors face a different assessment. Lenders generally consider a combination of salary and dividends drawn from the company before tax.
However, some lenders might opt to assess the net profit plus salary, which can be more advantageous. This method is beneficial as it avoids the need for the sole trader or director to draw higher dividends, thereby incurring more tax, to improve their mortgage prospects.
How Can I Secure A Mortgage When Self-Employed?
Self-employed mortgage applicants should focus on presenting their income in the most favourable light, in line with how lenders assess their specific business structure. For contractors, this often means leveraging their gross contract value to enhance mortgage affordability. Sole traders should highlight their net profits, while limited company directors might find it advantageous to focus on a combination of net profits and salary, or in some cases, just the salary and dividends, depending on the lender’s preference.
Preparing Your Mortgage Application
When preparing your mortgage application, ensuring that your income is consistent and meticulously documented is crucial. This is especially important for self-employed individuals, as their income may fluctuate more than that of salaried employees.
Clear, comprehensive documentation, such as certified accounts prepared by a qualified accountant, is key to explaining any income variations or irregularities.
Working with specialist mortgage brokers can be particularly beneficial in this process. They can assist in ensuring that all necessary documents, including self-certified mortgages if applicable, are in order and presented effectively to the lender. Mortgage brokers have the expertise to navigate the complexities of self-employed mortgage applications and can provide invaluable guidance in maximising your chances of approval.
Gross Vs Net Income: What Do Lenders Prefer?
For employed people lenders use their gross salary. Self employed income is often a more complicated calculation. If you are a contractor then many lenders will see you as employed even though you have your own self employed vehicle behind that contract. For sole traders and limited company directors lenders will look at your share of net profits alongside any salary you pay yourself. Your net profits are technically your gross income as this is before any personal tax and NI has been paid. Some lenders consider limited company profits before tax, some after. The gross day rate is often considered for contractors, reflecting their unique income structure. In contrast, sole traders are assessed on net profits, and limited company directors are typically evaluated based on salary and dividends. Some lenders, however, are open to considering net profits plus salary for limited company directors, offering a more advantageous route for mortgage applications.
Jones and Young: The Contractor Mortgage Experts
At Jones & Young, we stand out among mortgage companies as an independent mortgage lending firm based in Petersfield, Hampshire. Our services cater to a diverse client base across the UK, including sole traders, first-time buyers, and self-employed business professionals.
Our team specialises in various mortgage services, catering to first-time buyers, self-employed individuals, and CIS customers, among others. We focus on providing tailored solutions for more complex mortgage scenarios, including portfolio landlords, commercial mortgages, and later-life lending.
With over 10 years of experience in the industry, we are committed to delivering professional and personalised mortgage advice.
Let’s take a look at some of the most frequently asked questions about mortgage lenders.
Gross income is the total income an individual earns before any deductions are made, encompassing wages, salaries, bonuses, and other earnings, while net income is what remains after deductions like taxes and National Insurance are subtracted from the gross income.
This distinction is crucial for financial planning and mortgage applications, as lenders assess these figures to determine an individual’s borrowing capacity and repayment ability, with gross income offering a broad view of earning capacity and net income reflecting the actual disposable income.
It can be more challenging for self-employed individuals to secure a mortgage, primarily due to the variability and complexity of their income. Lenders typically require a longer and more stable income history from self-employed applicants compared to employed ones.
However, with sufficient financial records, credit rating, and stable earnings, self-employed borrowers can successfully obtain a mortgage, especially from lenders who specialise in or are more accommodating of self-employed applicants.
For employed individuals, mortgage lenders usually look at gross salary, which includes the basic salary plus any regular additional income like overtime and bonuses. Gross income provides a broader picture of the applicant’s total earnings before deductions.
This approach often benefits the borrower by showing a higher level of income, potentially leading to a larger borrowing capacity. However, for self-employed individuals, lenders often consider gross profit before tax to understand the full scope of business income. They may also take into account net profit figures, especially when assessing affordability and existing financial commitments.
In the context of mortgage applications, ‘net profit’ typically refers to the profit remaining after all operating expenses, but before tax. This figure is crucial for self-employed individuals, as it reflects the earnings from their business activities.
Lenders use this pre-tax net profit figure to gauge the financial health and earning capacity of the business. It provides a more accurate representation of the business’s financial performance and potential for future earnings, which is essential for assessing the borrower’s ability to afford and repay the mortgage.
Typically, mortgage lenders in the UK request three months’ worth of recent payslips from applicants. This is to assess the stability and regularity of your income.
However, if your income includes variable components such as bonuses or commissions, you may need to provide up to six months of payslips to demonstrate their consistency. For those who are self-employed, the documentation required is different, usually encompassing two to three years’ worth of financial accounts.
In the UK, the verification of income by mortgage lenders varies based on the applicant’s employment status. Employed individuals are usually asked to submit their latest payslips, P60 form, and recent bank statements. Sometimes, lenders may also verify income details directly with the employer.
The process involves a more in-depth review for self-employed applicants, typically requiring the last two to three years of SA302 tax calculation forms from HMRC along with the corresponding Tax Year Overviews. This is supplemented by bank statements and detailed profit and loss accounts, which may include business balance sheets. In some cases, self-employed individuals might also need to provide an accountant’s certification or other professional references to confirm the stability and reliability of their income.