Getting a home loan when you're self-employed (without two years of pain)

There is a contradiction sitting at the centre of every self-employed home loan application, and most borrowers do not find out about it until they are already knocked back.

Your accountant's job all year has been to legitimately reduce your taxable income. The lender's assessment is based on your taxable income. The better the tax result, the worse the borrowing capacity.

This is fixable — but it has to be planned, and the planning window is roughly two years before you apply, not two weeks.

What lenders actually ask for

For a full-doc self-employed application, most lenders want:

• Two years of personal tax returns and notices of assessment
• Two years of business financials — profit and loss and balance sheet — for a company, trust or partnership
• Recent BAS or business bank statements to show the current year is tracking consistently with history
• Evidence the ABN and GST registration have been active long enough, typically 12 to 24 months

Some lenders will accept one year of returns where the business is established and the figures are strong. That is a real and useful concession, and it materially widens the field for someone who has just come off a good year.

The consistent theme is that lenders are looking for demonstrated, sustainable income. A single spectacular year following two average ones is usually assessed on an average, not the peak.

Add-backs: the part that recovers your borrowing power

Lenders will add certain non-cash or one-off expenses back to your taxable income, because they do not represent money that actually left your pocket. Policies vary by lender, but the common ones are:

• Depreciation — a paper expense, added back almost universally
• Additional superannuation above the compulsory guarantee — discretionary, so added back by most
• One-off expenses — a genuinely non-recurring cost, with evidence
• Interest on debts being refinanced or paid out by this transaction
• Net profit retained in the company, where you own it — some lenders will use it, some will not, and this one is worth shopping
• Motor vehicle and home office expenses — partial add-backs at some lenders

Add-backs are where a broker earns their keep, because the policy differences between lenders are large. The same set of financials can produce a borrowing capacity that differs by hundreds of thousands of dollars depending on which lender assesses it. That is not an exaggeration — retained company profit and trust distribution treatment alone can swing a self-employed assessment dramatically.

The two-year planning window

If you know you want to buy in two years, the sequence that works:

Year one. Have an honest conversation with your accountant about the trade-off. Aggressive deductions save you tax at your marginal rate. They cost you borrowing capacity at roughly five to six times the reduced income, depending on rates and your other commitments. For a borrower planning a purchase, the second number is usually the bigger one.

Year two. Keep the income presentation clean and consistent. Get the returns lodged early — an unlodged prior year is one of the most common reasons an otherwise strong application stalls, because most lenders will not proceed without the notice of assessment.

Throughout. Reduce and consolidate consumer debt. Every credit card limit — not balance, limit — reduces capacity, because lenders assess a minimum repayment against the full limit. Closing an unused $20,000 card can be worth more to your application than a year of extra income.

And do not restructure right before applying. Moving from sole trader to a company resets your trading history in the eyes of many lenders. If a restructure is coming, do it well before or well after, not three months out.

Low-doc and alt-doc, honestly

Where full documentation is not available — recent restructure, a year not yet lodged, or a business whose returns genuinely do not reflect current trading — some lenders will assess on alternatives:

• BAS-based — typically six to twelve months of activity statements
• Business bank statements — usually six to twelve months of trading account turnover
• Accountant's declaration — a letter from your accountant on income, accepted by fewer lenders than it used to be

What to expect in return: a higher interest rate, a lower maximum LVR (often 80% or less), and lender's mortgage insurance considerations. This is a legitimate product for a legitimate situation. It is not a way around affordability, and responsible lending obligations still apply in full — a lender must still be satisfied the loan is not unsuitable for you.

Used well, alt-doc is a bridge: take the loan now, refinance to a full-doc product at a sharper rate once two years of clean returns exist. That plan should be written down at the start, not hoped for later.

What actually gets applications declined

In rough order of frequency:

1. Unlodged tax returns. The single most common blocker, and the easiest to fix.
2. ATO debt. An outstanding ATO liability is treated as a serious adverse signal by most lenders, and since ATO debts can now be reported to credit bureaus in defined circumstances, it can also hit your credit file. A payment plan in good standing is far better than an unmanaged debt, but it is still a liability in the assessment.
3. Declining turnover. Where the most recent year is materially below the prior year, most lenders assess on the lower figure.
4. Messy bank accounts. Personal and business transactions mixed together make an assessor's job harder and make everything look less controlled.
5. Too many enquiries. Every application leaves a mark on your credit file. Five applications in three months reads as declined four times, whether or not that is what happened. This is the strongest argument for one broker submitting once to the right lender.

What to do before you talk to anyone

• Get both years lodged.
• Clear or formalise any ATO debt.
• Cancel unused credit cards and reduce limits on the ones you keep.
• Separate business and personal banking properly.
• Pull your own credit report and check it for errors.
• Have your accountant and your broker talk to each other before the application is written.

That last point is the reason we do both. When the person who prepared the financials and the person submitting the application are the same team, the add-backs are identified up front, the lender is chosen for the way it treats your structure, and the application goes in once — correctly.

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General information only. This is not credit assistance or a recommendation, and it does not consider your objectives, financial situation or needs. All lending is subject to credit assessment and individual lender criteria; fees, charges, terms and conditions apply. To talk about your own scenario, book a free consult.