How Banks Assess Self Employed Income
If you're self-employed banks will usually need more from you before they'll lend compared to a PAYG employee. But that doesn't mean buying your first home is out of reach, it just means there's more to understand about how your income is assessed and how to present it in the best possible way.
In this resource we're covering:
How banks assess self-employed income
Why one year of financials could significantly increase your borrowing capacity
How the director wages pathway could change what you're able to borrow
What your options are if your ABN is less than two years old
Your tax returns and why speaking to a broker before you lodge is so important
This resource supports Episode 38 of the First Home Unlocked Podcast: Unlocking How Banks Assess Self-Employed Income.
Why Self-Employed Income Is More Complex
Your situation is harder and it's more complex. As you get more complex in your business structure the more experience your broker needs to have to help you navigate this.
When a bank looks at a PAYG employee it's pretty straightforward. They look at your payslips, the income is consistent and that's what they use in their assessment. Self-employed income is different. It can vary from year to year, it shows up through tax returns rather than payslips and the way your business is structured affects how it's calculated by the bank.
There are a lot of advantages sometimes but there's also a lot of disadvantages with being self-employed. As soon as you step into the self-employed world every bank does look at it a bit differently. This is where we really care about who we lodge a loan through and how we position you to the bank.
There's a lot of value in great brokers when you're self-employed, not just with getting residential finance but it might shift into some business finance or commercial lending in the future. There's a lot more going on when you're self-employed.
The Key Message: Lender Selection Matters Most
For self-employed buyers lender selection matters more than anything else. There are different ways lenders can look at your income and different ways we can present you to the bank. A great broker adds a lot of value if you've got PAYG income and you're borrowing well within your limits you could probably walk into any bank and pretty much get the same product at the same rate, but as soon as you step into the self-employed world the differentiation between lenders can be huge.
The Standard Approach: Two Years of Tax Returns
Most lenders will look at two years of tax returns and business financials and the number they're focused on is your net profit.
They want two years because one strong year doesn't prove your income is sustainable. They want to see consistency before they're comfortable lending. So lenders look at your net profit across both years and use the average. If one year was quieter than the other that lower year reduces the average and also reduces what you can borrow.
The Tax Minimisation vs Borrowing Capacity Trade-Off
Something that comes up a lot with self-employed first home buyers is the trade-off between tax minimisation and maximising your net profit figure.
You're working with your accountant to claim deductions and reduce your net profit which reduces your tax bill. That makes complete sense from a tax perspective. But that same net profit is exactly what the bank uses to work out how much they'll lend you. So the more you reduce it for tax the less you can borrow.
If buying is on your radar it's really important to be having that conversation with your accountant and broker early. Because if you've spent the last two years minimising your net profit to reduce your tax bill the amount you can borrow from the bank will be reduced. The earlier you start thinking about finding the right balance between your tax and home ownership goals the stronger position you'll be in when it comes time to buy your first home.
A lot of self-employed people will try to minimize their tax and they'll do all the legal right things to do it. But they haven't thought about buying a property and then all of a sudden they want to buy a property and they haven't given themselves that option. They've reduced it down so much that the bank's not going to lend them enough to buy what they want to buy.
One Year of Financials: A Game Changer
The one year financials policy allows some lenders will actually assess you on just one year of financials rather than requiring the full two years.
If your most recent year was significantly stronger than the year before using just that one strong year could give you much higher borrowing capacity than averaging both years together.
Let's say your net profit last year was $100,000 but the year before that it was only $60,000. If a lender averages those two years you're being assessed on $80,000. But if a lender uses just the most recent year you're being assessed on the full $100,000. That difference could mean tens of thousands of dollars more in borrowing capacity.
Not all lenders offer this but the ones that do can make a real difference for self-employed buyers who've had a strong recent year. This is exactly why working with a broker who knows which lenders have these policies matters so much.
Director Wages: An Alternative Pathway
If your business is structured as a company you might have access to what's called the director wages pathway.
This is where instead of the bank looking at your net profit they look at the wages you're paying yourself as a director. If those wages have been consistent for six to twelve months some lenders will treat you more like a PAYG employee rather than a self-employed borrower.
Why This Matters
The director wages pathway can be really powerful for two reasons.
First, you don't need two years of financials. If you've only been paying yourself director wages for six months or a year some lenders will still work with you. That opens up options for buyers who've recently restructured their business or who haven't been self-employed for long.
Second, it can give you higher borrowing capacity in some cases. If you're paying yourself consistent wages but your business net profit is lower (maybe because you're reinvesting profits back into the business) the director wages pathway might give you a better result than the standard net profit approach.
The Trade-Off
The trade-off is that you need to be paying yourself enough in wages for it to be worthwhile. If you're only drawing $60,000 a year in wages but your net profit is $100,000 you'd be better off using the standard approach.
Also not all lenders offer the director wages pathway so again lender selection really matters here, a good broker will know which lenders have this option and when it makes sense to use it.
What If Your ABN Is Less Than Two Years Old?
If your ABN is less than two years old your options are more limited but they're not gone entirely.
Some lenders will work with you if you've been in the same industry for a number of years even if your ABN is new. For example if you were working as a PAYG employee in construction for five years and you've recently started your own construction business some lenders will consider your industry experience even though your business is less than two years old.
There are also a handful of specialist lenders who will look at self-employed buyers with ABNs under two years old but they typically require a larger deposit and the rates are usually higher. It's not the ideal pathway but if you're in a position where you need to buy sooner rather than later it can be an option.
The key here is not to assume you have no options just because your ABN is new. Come and have a conversation with a broker and we can look at what's actually available for your specific situation.
Addbacks: Increasing Your Assessed Income
Some lenders will allow you to use an addback which is when a lender takes a business expense from your tax return and adds it back to your net profit. This increases your assessed income and therefore your borrowing capacity. The most common addbacks are:
Depreciation on business assets. It shows up as an expense on your tax return but it's not actually cash leaving your account. Most lenders will add some or all of it back but the percentage varies. Some lenders allow the full amount, others cap it at 20% or 50% so lender selection matters here too.
Extra super contributions above the compulsory rate because those are a choice you made rather than a fixed business cost.
One-off expenses that won't repeat like a specific legal cost or a project that's now finished. These usually need a letter from your accountant confirming they're not ongoing.
The key here is that addbacks can increase what the bank assesses your income as without anything about your actual financial position changing.
The Instant Asset Write-Off Trap
We've also seen business owners use the government's instant asset write-off to depreciate equipment or vehicles in full in a single year. It's a great tax strategy but it significantly reduces your net profit on your tax return.
The good news is that a number of lenders including some of the major banks will allow you to add that write-off back as a one-off expense which can make a real difference to your borrowing capacity. But not all lenders treat it the same way which is why it's important to chat with a broker so we can put you with the best lender for your situation.
Business Debts and Your Personal Borrowing Capacity
If your business has debts like equipment finance or a business overdraft it's worth knowing that many lenders will actually exclude those business debts from your personal borrowing assessment entirely.
They see the business as covering those commitments from its own cash flow. A smaller number of lenders will count them against your personal borrowing capacity.
That's actually a really positive thing for a lot of self-employed buyers because it means those business commitments won't drag down what you can borrow personally. It's one of the reasons lender selection really matters for self-employed buyers.
Why You Need to Speak to a Broker Before You Lodge Your Next Tax Return
If you're self-employed and buying is on your radar the most important thing you can do is speak to a broker before you lodge your next tax return.
Most self-employed people work with their accountant to reduce their taxable income which makes complete sense. But the lower your net profit is on paper the less the bank will lend you and the fewer pathways like director wages you'll have access to.
Once your tax return is lodged your options are set. But before it's lodged there's a real opportunity to get the balance right.
Connecting Your Broker and Your Accountant
The way you do that is by connecting your broker and your accountant. When the three of you are working together your broker can give your accountant a clear picture of the income level you need to hit your borrowing target. Your accountant can then structure your tax return with that in mind.
You're not choosing between a good tax position and a good lending position. You're finding the right balance between both.
I've seen it go both ways. Buyers who came to us early, we connected with their accountant, we found that balance and they were able to borrow what they needed. On the other hand we've seen buyers who came to us after the return was already lodged. Their net profit was lower to save more on tax but then their borrowing options were limited.
The earlier you start that conversation the more doors that stay open for you.
There are some brokers that won't even talk about tax returns because they don't want to encroach on what an accountant does. But you've got to get a good broker that really understands this stuff particularly if you've got a complex business with lots of different entities. Some accountants can get very creative on how those entities are set up and the broker's got to be able to explain to the bank sometimes how those entities work as well.
Final Thoughts
For self-employed buyers this shouldn't be a roadblock to buying your first home. What it means is that you need to be strategic about how you present your income and the lender you choose. There are a lot of pathways available to you, you just need to find the right one for your situation.
The buyers who get the best outcomes are the ones that start that conversation early, connect their broker and their accountant, and don't make assumptions about what's available to them before they've actually spoken to someone.
If you want to talk things through you can Book a Get to Know You Chat. We'll help you work out exactly where you stand and map out what your next step looks like.
