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As a company owner, you may be paying yourself through a combination of salary and dividends, which can be a tax-efficient way to withdraw money from your business. You might choose to leave some of your profits in the company for tax planning purposes or because you simply don’t need to draw on the money right away.
However, this can create issues when it comes to getting a mortgage. Most mortgage lenders aren’t well-equipped to deal with the unique financial situation of company owners, and they often only consider your salary and dividends as a basis for your earnings.
This can seem unfair, as it doesn’t take into account the company’s retained profits. The good news is that there are lenders who do consider retained profits when assessing your mortgage application. So, don’t worry, there are options available to you!
What are retained profits?
Retained profits are the profits that a company keeps within the business after dividends have been paid out to shareholders. These profits are reflected in the company’s profit and loss statement.
One reason that companies may choose to retain profits is for tax purposes. By leaving a significant amount of profits within the company and not drawing a salary or paying out dividends, the business can reduce its taxable income.
However, it’s important to note that companies may still be subject to other taxes such as corporation tax, which is a tax on a company’s profits.
Retaining profits can be a smart financial move for companies, as it allows them to reinvest in the business, pay off debt, or build up a financial cushion for the future.
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Why don’t mortgage lenders like using retained profits?
Some mortgage lenders may not take retained profits into consideration when assessing a company owner’s income for a mortgage application.
This is because retained profits are funds that are kept within the business and not distributed as dividends to shareholders.
As a result, there is a risk that these profits may be used up later on for business expenses or other purposes, leaving the company owner with less income to make mortgage payments.
Company director Income
The optimal salary and dividend amount to pay yourself as a company owner for tax reasons can vary from year to year and will depend on your individual circumstances. In the 2023/2024 tax year, the limit for most company owners is usually around £50,000 in salary and dividends, although this can fluctuate depending on various factors such as changes to tax laws or individual financial situations.
It’s worth noting that even if a company has a profit of £100,000, many mortgage lenders may only consider £50,000 of that income when assessing a company owner’s mortgage application. This is because they often use a standard calculation based on salary and dividends, which may not fully reflect the company’s financial situation or the owner’s ability to repay the mortgage.
What options do you have if your salary and dividends combined don’t provide enough evidence that you can afford a mortgage?
Thankfully, while some mortgage lenders may only consider salary and dividends when assessing a company owner’s income for a mortgage application, there are also lenders who take a more favorable view and consider the profit and salary instead.
This can be particularly advantageous for company owners who have substantial retained profits within their business, as it allows them to demonstrate a higher level of income and increase their chances of being approved for a mortgage.
Is a mortgage calculated on turnover or profit?
As the saying goes, “turnover for show, profit for dough.” This is also true in the mortgage world, where lenders typically focus on a company owner’s salary and dividends or salary and profit when assessing their income for a mortgage application.
While turnover can be an important indicator of a company’s success, lenders are generally more interested in the amount of money that you can realistically use to make mortgage payments.
Can I get a mortgage using retained profits?
Absolutely, while some mortgage lenders may not consider retained profits when assessing a company owner’s income for a mortgage application, there are lenders who do take into account retained profits as a viable source of income.
Most lenders who consider retained profits typically use a combination of the owner’s salary and the retained profit after corporation tax has been deducted.
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However, a few lenders do accept salary and retained profit before corporation tax.
In addition, many lenders require the applicants to be the only directors and shareholders in order to consider using retained profits as income for a mortgage application.
Affordability
Lenders may use a range of methods to assess affordability, such as income multiples, affordability calculators, or stress testing scenarios to determine how the borrower’s finances would fare in a variety of circumstances.
Here are some common factors that mortgage lenders may use to assess affordability:
- Income (e.g. salary, dividends, profit)
- Credit history
- Debt-to-income ratio
- Employment history/stability
- Monthly expenses (e.g. utilities, bills, insurance)
- Amount of deposit available
- Value of the property being purchased
- Term of the mortgage
- Interest rate
- Other financial commitments (e.g. child care costs, other loan repayments)
How much can I borrow?
Mortgage lenders usually consider various factors such as credit history, employment status, debt-to-income ratio, and the purpose of the loan.
However, one of the most important factors that lenders take into account is the borrower’s income.
As a general rule of thumb, most lenders may consider lending around 4-5 times the borrower’s annual income. However, this may vary depending on the lender’s policies and the borrower’s individual circumstances.
For instance, borrowers with higher incomes may be able to secure larger loans with higher multiples than those with lower incomes.
Retained profits vs salary and dividends Example
- Limited Company
- One shareholder/director
- £100,000 retained profit
- £9,000 PAYE salary
- £40,000 dividends
if the borrower’s income consists of a £9,000 salary and £41,000 in dividends, most lenders would use this information to calculate the borrower’s income for lending purposes.
Assuming a 4.5 times income multiplier, the maximum amount the borrower can borrow would be:
- £50,000 x 4.5 = £225,000 borrowing
A specialist lender would take into account the retained profit within the business, and so your affordability will be based on a minimum of £149,000 which, when multiplied by 4.5 would mean you could borrow £670,500.
- £149,000 x 4.5 = £670,500 borrowing
A whopping £445,500 extra borrowing.
Retained profit mortgages with higher income multiples
One of the most significant factors in determining the income multiples a lender may offer is the level of your income. Most lenders typically offer around 4.5 times your income, although higher multiples may be available for those with incomes above a certain level, such as £75,000 or £100,000.
This means that a lender who considers retained profit over salary and dividends may not only evaluate a higher income level for affordability but also offer higher multiples.
I’m in a shared partnership, how can I use my retained profits to get a mortgage?
If you do not own all of the company, not all lenders may accept retained profit and salary as a basis for calculating your income for lending purposes. However, for those lenders that do accept this method, they may consider your share of the retained profit, in addition to your salary and dividends received over a specific period.
What documents will I need?
If you’re a company director using retained profits to apply for a mortgage in the UK, here are some of the documents you may be required to provide to the lender:
- Tax returns: Two to three years’ worth of tax returns filed with HMRC, which will show your total income, net profits, and any expenses claimed
- SA302 tax calculation: which is a summary of your income, tax paid, and National Insurance contributions due
- Company accounts: for the past two to three years prepared by a qualified accountant
- Accountant certificate: A letter from your accountant certifying your income based on your company’s accounts
- Business bank statements: to show the business income and expenses
How is self-employed income calculated?
Most lenders typically consider an average of your most recent two years’ accounts when assessing your eligibility for a mortgage.
However, some lenders may consider an average of the last three years or the most recent year’s accounts.
It’s also worth noting that some lenders may require a minimum of two years of trading history, while others may accept just one year.
If your income is on a declining trend, most lenders will usually take the lower of the two years’ income when assessing your affordability for a mortgage.
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What mortgage deals are available?
When using retained profits as a self-employed company director for a mortgage, you may be eligible for various types of mortgages. Here are some examples:
- Fixed-rate mortgages: These mortgages come with a fixed interest rate for a specific period, typically between 2-5 10 years. This means that your monthly repayments will remain the same throughout the fixed-rate period.
- Tracker mortgages: These mortgages have an interest rate that tracks a set rate, usually the Bank of England base rate plus a certain percentage. This means that your repayments could increase or decrease based on any changes to the underlying rate.
- Variable-rate mortgages: These mortgages have an interest rate that can change at any time at the discretion of the lender. Your monthly repayments may increase or decrease based on any changes to the interest rate.
- Repayment mortgages: These mortgages require you to make monthly repayments that cover both the interest and the capital amount borrowed. This means that at the end of the mortgage term, you will have fully paid off the loan.
- Interest-only mortgages: These mortgages require you to pay only the interest on the loan, and you will need to make separate arrangements to repay the capital at the end of the mortgage term. Interest-only mortgages can be riskier as you may not have a clear repayment plan in place.
Which mortgage lenders consider using retained profit income?
Barclays, HSBC, Coventry Building Society, Virgin Money, and Metro Bank are some of the mainstream lenders in the UK that may consider retained profit as part of a borrower’s income for lending purposes.
How can strive Mortgages help?
The availability of these types of mortgages can vary depending on the lender and your individual circumstances.
Having an experienced mortgage broker like Strive who understands the nuances of self-employed mortgages can help you secure the right deal and give you the best chance of success with your application.
For more info on retained profit mortgages, please contact a member of the Strive team, by emailing [email protected] or call us on 01273 002697.
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Jamie Elvin
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