Risk is a huge consideration when it comes to banks and responsible lending. When you are applying for a loan with a bank, they will want to minimize their exposure to risk in a whole number of ways.
The main one is to ensure you have a reliable income with which you can make repayments on a loan.
Reliable income is easier to prove when you work for a company on a salary. The bank can see how long you have been employed there and consistent yearly earnings. But when you are self-employed, you are the only one guaranteeing your earnings.
People being self-employed these days is more common than ever, with an increase in freelancers, contract workers, side hustles and gig economy workers.
Even so, lenders will likely view you as riskier than others. You might have one successful year where you earn the big bucks, only to have two quiet years right after that. Therefore, banks will get a little more forensic before your loan application is approved.
So how do I prove my income?
When you’re self-employed, lenders have traditionally required detailed documentation such as tax returns, financial statements, bank statements, individual notices of assessment, and comprehensive and meticulously kept business records, all spanning a minimum of two years.
But a few years back, the Covid pandemic and subsequent lockdowns disrupted and reduced people’s income, but the government needed people to keep borrowing and spending to keep the economy afloat.
So, something had to give when it came to proof of income. Enter simplified income verification.
Simplified income verification
Simplified income verification saw some banks allow self-employed borrowers to prove their income with six months’ worth of payslips or income statements showing a YTD income, plus a letter from an accountant confirming the wage is sustainable and continued to be paid and the borrower could meet their commitments.
Several lenders have since got on board with the newer way of doing things, though some will differ slightly, depending on their risk assessment methods.
Some might assess self-employed people with a company or trust structure, but not sole traders or partnerships.
Before applying, chat to a mortgage broker, your accountant, and any other experts you rely on for financial advice to ensure you are presenting yourself in the best light.
How’s your credit score?
The next thing you need to know is to get your credit score in tip-top shape. Lenders use credit scores as a measure of your creditworthiness, which can not only influence whether you are approved but also the interest rates and features you are offered on a loan. You can access your credit score or rating from providers such as Equifax and Experian. If you have payment defaults in your history, it’s best you know about them and see what action you can take to improve your credit score before attempting to borrow.
Genuine savings and strong deposits
Banks will want to see evidence of your genuine savings, which helps them measure how good you might be at managing money. In the current cost of living crisis, it’s difficult to save much money, especially if you are paying rent and it has gone up lately.
The good news is that more banks are treating rental payments as proof of genuine savings these days, so this might work in your favour.
Then there’s the deposit. Banks love big deposits as it means that in the event you default on your repayments, they are more likely to be able to recover the money they have lent you if they need to sell your house.
The genuine rule for a regular borrower is that banks like to see a 20% deposit. If you’re self-employed, having a 30% or higher deposit will be helpful.
Declaring your income
Finally, self-employed individuals are often able to structure their income to minimize their tax liability. This can save money on tax and may seem like a brilliant thing at the time, but it can hinder your loan application because it may look like you are earning less than you are and are therefore at greater risk of not meeting repayments.
