Using retained net profit figure towards income when applying for a mortgage
Last year my company had its most profitable year yet but we didn't pay out dividends on all of the net profits as per my accountants advice. My wife and I recently found the house of our dreams but when we went to my bank they declined me based on affordability.
This is baffling as I have my share of the profits ready to be taken out if needed but I don't want to use them if I don't have to. Worse still, even if I do pay them out now my bank told me that I would have to wait until the next tax year before I can reapply with that amount counted towards my income. This seems absolutely crazy as, to any sensible person, it would seem obvious that I could comfortably afford my mortgage. I don't want to miss this house! Is there anything I can do? Help!
One of the biggest issues self-employed borrowers come across is finding the right advice when it comes to affordability, and which figures from their accounts are the right ones to use. This is unfortunately prevalent across the industry, and we receive hundreds of enquiries from Ltd company directors that have been declined by their bank and/or messed around by a broker who didn’t fully understand the situation. To those who ask, we say don’t panic!
Directors of successful companies who have decided not to withdraw all of their profits (thus not paying income / dividend tax on the money) are limited by most lenders to simply borrowing based on the income they have drawn, and most mainstream and specialist lenders will only consider a directors’ annual salary + dividends toward affordability calculations, which can have a huge impact on maximum borrowing amounts.
The argument is that people should only be able to borrow based on their actual personal earned and taxable income, because if income has not technically been drawn then it belongs to the Ltd company and not the individual. Thankfully not all lenders are the same.
The policy of a select few lenders accommodates directors on the basis that they have simply chosen not to withdraw their earned money, but could have if they wanted to – in other words the affordability was there, they just left the cash in the business rather than moving it into their personal account.
An example: A 50% shareholder / director of a Ltd company that has a net profit of £500,000 draws a £10,000 salary plus £30,000 dividends in the last 3 years, what is the maximum borrowing available?
The policy of almost all lenders in the market would consider the income to be £40,000 a year, with the most generous lending 5x this amount = £200,000 max borrowing. The specialist lenders would take into account the share of the net profit irrespective of the dividends (and some can even build the £10,000 salary back into it too), meaning that in the worst case scenario, affordability would be based on an income of £250,000, which when you apply a standard 4x income calculation = £1,000,000 max borrowing. Quite the difference!
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