Mortgages for company directors: how to use company profit to get the size of loan you need
You’re an entrepreneurial business-owner trying to arrange a mortgage. Surely you should be able to count the profit retained in your company towards your mortgage affordability calculations?
Or are you a self-employed contractor or freelance professional who manages their work through a limited company?
Step forward all you IT consultants, accountants, web designers, book keepers, surveyors, financial advisors and HR consultants who are up at the pointy end of the contracting-out revolution.
If you’re in the kind of business where
- clients expect to be paying a company, rather than a sole trader
- you need the protection of limited liability
- and /or if you’re earning more than £85K a year
then you’ll be the director/ shareholder of a limited company.
How do mortgages for company directors work?
In return for the daily stresses and lack of security that come with working for yourself and the entrepreneurial chutzpah it takes to be a business owner, you’ll be hoping – not unreasonably – that there will be some tax advantages that will make it worthwhile to be running your own company.
And if you’re reading this blog, you’re particularly hoping that your company set-up can help you get the mortgage borrowing you need.
The good news
But only if you go about it the right way. And know which lenders to approach.
This is where good mortgage advice is essential.
The bad news
You could lose out as a company director if you don't approach it correctly.
Example Case Study:
Our clients were a husband and wife who run a successful small company working in recruitment.
The husband is a director, and the wife earns a salary from the company.
They had just had one of their best years in the business. The seven-day working weeks of setting up a small business were paying off. It seemed reasonable to go house-hunting for the family home they’d always dreamed of.
They found 5 bedrooms in Surbiton, Surrey, where they live, for £1.2M.
But when they went to their bank, they were turned down for the mortgage they needed of just over 50% of the value – on the grounds of affordability.
They were prudent business owners, and following their accountant’s advice, they'd paid themselves modest salaries that keep them below the tax threshold. The husband took a dividend of around 25% of the company’s net profits. The remaining 75% of the profit was left in the company’s accounts.
The bank’s decision seemed like madness to them: as sole owners of the company, they could afford the size of mortgage they were looking for.
They were advised they’d have to wait to reapply until the following year when they could pay out the profit as a dividend that could be counted towards their income (but they would then need to pay dividend tax on it). More details »
Here’s what’s happening with the calculations:
They’re each taking a salary of just under £10,000
The husband's dividend was £30,000
The net profit left in the company was £112,000
Most high street lenders will consider drawn income only = £50,000 a year x5 (the most favourable affordability ratio) = max £250,000 in borrowing.
What’s the solution?
Was their accountant wrong to advise them to leave profits in the company?
In terms of tax efficiency, no.
If you're like our clients, you may have been advised to take the optimal director’s salary of less than a certain amount per year from your company.
- Salaries are a tax-deductible expense: the company saves corporation tax at 19% on gross salary costs.
- You take a director’s dividend from the company for the remainder of your living expenses. National Insurance doesn’t have to be paid on dividends.
- Dividend tax payable on your dividend starts at 7.5% - up to 38.1% for dividend earnings over £150K.
- The remainder of the company’s net earnings is left as "retained profit". You don’t pay dividend tax on dividends that aren’t paid out.
You need a specialist lender
All well and good for tax minimisation.
But now you want to apply for a mortgage – or a bigger mortgage.
- As our clients discovered, drawn income in the form of salary plus dividend isn’t going to get you the size of mortgage borrowing you may want.
- If you’re like them and you own a company showing good profitability. Still, if you chose to leave profit in the company rather than draw it down, you need a lender who takes a broader view of the ownership of limited company income.
- But you won’t find them on the high street.
The conventional view of mortgage affordability is that it should be based only on an individual’s actual earned and taxable income.
These banks and building societies will consider that income that has not been drawn down from a company, even if solely owned, belongs to the company rather than the individual.
Access the borrowing power of retained profit
Fortunately, high-street lenders are no longer the only sources of mortgage finance.
- Specialist lenders such as private funds, mutual funds and smaller challenger banks take a more flexible, "bespoke" approach to their lending decisions.
- Parts of their mortgage application process are automated, but their decision-making is supplemented by real-eyeballs review by an underwriter who can take a common-sense approach.
In this case, we took our client's application to a lender who we knew would take into account this year’s net profit retained in the company and add it to the profitability calculation.
(Other specialist lenders might have wanted to see the company’s profitability over the past two or three years before making their decision.)
The result: net profit in the company plus salaries:
£112,000 + £10,000 + £10,000 = £132,000 x 5 = just short of £660,000 in borrowing.
Contact Clifton Private Finance
High street banks are accessible – as the name implies – to walk-up customers making a direct approach. But even if they’ve been your bank for years, that doesn’t mean they’ll produce the mortgage offer you need.
On the other hand, the wide range of specialist lenders are mostly accessible only via an intermediary broker.
- Small challenger lenders don’t have the capacity to direct prospective borrowers towards their most appropriate lending product.
- And they don’t have the customer support staff to guide borrowers through the details of the application process.
- In addition, their rates and lending criteria aren’t widely advertised, making it impossible for an individual to compare rates and terms across the market.
- So if you get direct access to a specialist lender and you manage to get an offer of terms, you’re in danger of researching terms from only one or two lenders.
The job of a specialist mortgage advisor such as Clifton Private Finance is to know about the full range of lending options available right across the market. One of our specialist brokers will be able to identify the lenders who will be willing to consider your particular circumstances (dividend income and retained company profit). And they can package your application to suit their criteria.
Please call our team on 0203 900 4322 or book a callback into our diary at a time that suits you.
And read our 7 ways to get a bigger mortgage with the right product.