David Conway, financial adviser at Clayhall Financial Services, said: “An accountant’s job is for their self-employed client to pay as little tax as possible and the way for them to do that is to go through every legal, taxable expense and reduce it, which might give them less income, which means they can’t borrow more.”
He said mortgage affordability was assessed either by the salary of a self-employed borrower and their business’ profit, or their salary and dividends drawn if they were limited company directors. For sole traders, their profit is worked out by deducting expenses from their turnover.
Conway said self-employed people did not have to declare all their expenses, but do need to declare all of their profit, meaning if they need to maximise borrowing, they will need to declare a higher income.
He added: “Nobody will take a mortgage adviser’s opinion before they file their tax return. If you ask an accountant to make sure their client pays more tax, that’s counterintuitive to the job of an accountant.”
Richard Campo, founder of Rose Capital Partners, said: “For as long as I have done this job, the tax regime for self-employed clients and lending criteria have always been diametrically opposed. That is particularly acute now as the tax burden is so great, clients are rightfully looking to minimise their tax liability.
“That is before you even get into the practical assessment of accounts and contracts which over a two to three-year track record will be affected by Covid.”
Graham Cox, director of Hub Financial Services, said: “Understandably many accountants minimise client’s income to reduce their tax liability. But it has the unfortunate side effect of making it more difficult for company directors or sole traders to get the mortgage amount they want.
“This is because the majority still use salary and dividends for directors, usually averaged over the last two years. However, some banks and building societies work off salary and the applicant’s share of net profit, often using the latest year’s accounts.”
Cox said this made “all the difference” but noted that there were still cases where applicants had to delay purchases until their accountant could produce the latest year’s accounts.
“The issue is further complicated when the borrower has other circumstances that make their case difficult to place. For example, if they get paid in foreign income. If they need a net profit lender as well, their choice of deals can become very limited. Often, they are left with one or two lenders at a much higher mortgage rate than they’d like or can afford,” he added.
Austyn Johnson, founder of Mortgages for Actors, said accountants did not usually advise the self-employed on how to show their full income to ensure they have a “good mortgage outcome”.
He added: “Sometimes, self-employed people such as builders easily take home around £50,000 and yet their tax forms show £20,000. This is also due to cash jobs not being declared or overexpanding on the expenses.
“If your tax adviser helps you to show a £20,000 income, then when it comes to mortgages, a maximum of around £100,000 would be able to be raised due to multiples. This will obviously disappoint the borrower.”
Johnson continued: “I personally do not see any of this to be an issue, as you should be declaring all income and being honest with your expenses. If you are dishonest, then you are unable to buy with as big a loan as you would like. You can’t have everything after all.”
Adam Wells, co-founder of Lloyds Wells Mortgages, said as a self-employed limited company director who is currently in the process of moving, the topic was “close to his heart”
Wells originally planned to move house in 2022 but because of how Santander assesses the income of limited company directors, he had to wait until his next set of accounts which was “frustrating as I’d have been on a nice, low rate”.
This year, he got a mortgage offer from Coventry Building Society who uses the latest year’s salary plus share of net profit.
Wells added: “They were very generous with their income multiples and allowed me to buy my new family home.”
Being aware of options
Conway said self-employed people could consider filing a tax return before the deadline to reflect a higher income if needed, as it is possible to file any time before then.
Separately, he said lenders could be more mindful of the circumstances of self-employed workers and consider looking at management accounts as “they reflect a real-time view of a business”.
Conway added that some lenders were willing to look at more recent accounts for affordability, but he did not know of any that accepted management accounts.
He also said it was not helpful that the tax returns submitted still included the pandemic period when many businesses were either not operating or conducting reduced operations.
Using himself as an example, Conway said the tax return he filed on 31 January 2023 only covered his income up until 5 April 2022, so that was all he could use for a mortgage until potential 31 January 2024.
He added: “There are ways to look at forward-thinking models, so instead of the last two years’ tax returns look at the last year’s tax return and bank statements since that time to reflect that.”
Wells said accountants were regularly asked by clients to minimise the amount of tax paid, and he had a friend who intentionally paid more tax over a two-year period so they could raise money for home improvements. This friend plans to reduce their tax liability going forward.
“Everything they are doing is above board and no different to an employed person working as much overtime and getting as much bonus as possible to maximise how much they can borrow,” Wells said.
Need for advice
Wells said lender assessments were still useful as they ensured borrowers were not over-indebted, adding: “The most important thing a self-employed person can do when it comes to their mortgage is to get some advice from a mortgage broker who can look at all the lenders and get them the best result.”
Cox said some lenders deducted Covid grants from self-employed client’s net profit and although it was less of a problem now, in 2022 this led to cases falling through as the profit did not stack up once the grant income was removed.
Johnson said lenders were doing the right thing, but added: “Occasionally there are instances where some extra consideration could be sought.”
Campo said he explained to clients that lenders would take at least one of the following into account when assessing affordability; salary, net profit, and profit on ordinary activities before tax and dividends. Then, it was about finding the lender who made the “most appropriate assessment based on the client’s objectives, figures and documents you can obtain”.
“Some lenders are excellent in this area, and we have had cases agreed recently where lenders have asked for pre-Covid figures. If they tally with the current year; they have ignored the Covid period. This is an excellent approach and I wish more lenders followed suit.”
