Getting a mortgage when you’re self-employed

Boxers & Briefs Podcast #43: What to do when applying for a mortgage as a business owner with Campbell Hastie

Business owners face a different challenge when applying for mortgages. No regular salary to show the bank. Income that wobbles from month to month. Financial accounts that tell a story, the bank needs to understand. Campbell Hastie has been helping people navigate this since 2005.

As owner and mortgage advisor at Hastie Mortgages, Campbell specialises in making the mortgage application process as stress-free as possible. His approval ratio sits between 90 and 95 percent, well above the 60 to 70 percent standard that banks expect from brokers. If he can’t get the loan approved, nobody can.

What makes a good mortgage broker

Campbell’s clients mention one thing consistently in their Google reviews. Communication.

One client recently came in for her final meeting. Her brother-in-law was buying a house at the same time through another mortgage broker. She told Campbell the experiences were like night and day.

“We have had four meetings in person before this one and three other Zoom meetings. We have had a whole heap of emails, numerous phone calls… You’ve hand-held us all the way through the process. We know exactly what we’re doing and why.”

Her brother-in-law’s experience? Fill in a form, provide some documents, here’s an approval, over to you. He was completely in the dark the entire time.

Communication matters. But it’s backed by analysis. Campbell and his team go through bank statements line by line. They do the drilling down, as he puts it. That analysis enables them to explain why they’re structuring a mortgage approval a certain way with a certain bank. It also reveals the levers clients can pull to change their outcome.

The combination of communication and analysis leads to solid advice. That’s what generates the approval ratio and the Google reviews.

The self-employed challenge

When you’re self-employed, proving your income becomes the hardest part of getting a mortgage. Business income wobbles around from week to week, month to month, certainly year to year. The bank needs to see consistency in that trading history, producing a level of income that supports a loan.

To prove that, you need your financial accounting done. It needs to be current for the financial year that just finished. That supports whatever story you’re trying to paint.

“There’s really no excuse to not have them in place these days. Things like Xero, MYOB, and others. There’s no excuse to not have that information to hand, to not have that information current.”

The last month, the last quarter, certainly the last financial year. If you have all that information, it’s far easier for the bank to see what you’re doing and get comfortable with your income level.

Writing off expenses versus proving income

Business owners often write off everything they can to minimise their tax bill. That’s sensible. Your accountant should still be doing that. But it creates a challenge when applying for mortgages.

Campbell starts at the bottom line of your financial accounts and works back up. He adds things back. Depreciation, interest, shareholder or director salaries. You might start with a net profit of $50,000 before tax, which isn’t enough to borrow a decent mortgage in Auckland. But there may be several things above that line that can be added back, turning that $50,000 income into $100,000.

The business owner knows they’re earning $100,000. They’ve just written half of it off legitimately. Campbell works backwards to reveal the true income picture.

The bank wants to see two years of trading history. That irons out the lumps and bumps. They get an average. They can see the business is solid enough to have traded for at least a couple of years. More is better, but two years is the minimum policy starting point.

Handling irregular income

Some businesses have a bump at Christmas. Others have a dip. It depends on the industry. The numbers themselves can’t be smoothed out, but the story matters.

“The bank’s got to understand why the lumps and bumps are there. It will be how you explain that in the application.”

Two years of trading history helps because you don’t see month-by-month variation in annual accounts. You just see the performance for the year, then the next year. The lumps and bumps show up in the interim report, which helps the bank understand your cash flow and whether you’re managing it properly.

From an accounting perspective, you shouldn’t do anything different. Record it accurately. Then tell the story about why things look the way they do.

One thing that helps is having a business plan. That provides the story behind the numbers. If you need to invest in something so you can be bigger the following year, the business plan explains that. The bank might not necessarily support it, but it helps them understand why you’re doing what you’re doing.

The drawings problem

Many startups don’t pay the owner a salary. Instead, the owner takes money as needed from the business account, and it gets marked as drawings.

The problem is that drawings are a reduction in capital of the business. They’re not income. Drawings aren’t taxed the same way, so the bank doesn’t see them as income. They can see money landing in your bank account, but it’s not taxable income. It’s something that reduces the balance sheet, whereas the bank is interested in what’s happening on the profit and loss from an income-earning perspective.

It’s not a mistake to use drawings, but it’s not strictly speaking income either. You need to be careful about that and understand why it’s happening and how it works from an operating performance perspective.

Separating business and personal finances

Business owners should absolutely separate their finances. Business versus personal. It comes down to transparency.

“You can see what is a business expense because that’s running through the business, and what is a personal expense, and that’s just running through your standard bank account.”

If you’re trying to prove your business performance and capability to a lender, you can’t have personal stuff muddled up in that. You might be a one-person band, but you have to separate it so the bank can clearly see how the business operates. The business generates the income. You have income. That income pays the mortgage. The separation matters.

It’s as easy as having separate bank accounts. Keep it simple. It’s not difficult.

When to buy property

Campbell always says yesterday. Yesterday is always the best time to buy property.

There are better times to buy property than others. The trouble is, you’ll never know if now is a better time than any other time because you only understand the answer to that question in retrospect.

It’s not worth trying to think about when is a great time to buy property. It’s better to approach the question by asking what you want to achieve by buying a rental property or three or four, or commercial, or maybe a mix. What are your goals? What’s your position? How do you bridge the two?

The numbers will inform what your capability is. In any market, there are opportunities staring you in the face. Whether the market is going up, down, or sideways, there are always opportunities.

Property was cheaper yesterday, literally yesterday, than today. It was cheaper 10 years ago, 20 years ago. If you had been able to buy then, you’d be very rich now. Yesterday, in that sense, is always better. But because you don’t know if your timing is good right now, all you’re left with is what you want to achieve and your current capacity. Your job is to bridge those two.

Campbell can help figure out what your borrowing capacity looks like. That will tell you whether you can buy something now or need to wait because some things in your financial picture need to change. Or maybe you can buy four properties right now. Some people are totally capable of it and don’t know.

Property isn’t the only option

Property is not the only asset that will go up in value or create wealth. It’s not the only option. For some people, it’s absolutely the wrong thing to do.

That runs against the Kiwi culture and ethos of buying property. White picket fence, two kids and a dog, then get a rental, then another one, maybe a holiday home. Then 30 years down the track, sell two, keep two freehold.

For some people, it’s too much to manage. Some can’t borrow that much money. Others don’t like the risk associated with rental property. That’s mostly to do with leverage and borrowed money.

The other risk property presents (that other investments don’t) is liquidity. If you need to offload an asset because you have a cash flow problem, it’s very hard to sell a property. More specifically, it’s very hard to get $100,000 out of a property and keep the property. You either borrow the money, and if you’re in trouble, you may not be able to do that, or you sell the whole thing. With a share portfolio, you just sell a bit. You can’t sell the lounge to pay off your debt.

It’s a lumpy investment. It lacks liquidity. So it’s not always the right thing for people to get involved with. But if you are going to, then yes, yesterday is a good time, as long as you know what your numbers are and what your targets look like.

The business owner mindset

Business owners are people who will take a risk. That’s why they’re in business. They tend to have a growth mindset. They see an opportunity to serve a particular niche in the market, so they start a business around that.

Getting involved with rental property is the same thing from a mindset perspective. You can see there’s an opportunity to create wealth by providing rental accommodation. That’s what it boils down to.

You need to be willing to take a punt. With property, it’s a rather large punt. Half a million dollars minimum. The punt is bigger than that because most people want to take that punt with someone else’s money, the bank’s, not theirs. So it ups the ante.

The mindset tends to be different. That’s not to say employees don’t get involved with rental property. Plenty do. But the mindset of someone in business is more aligned with the risk-taking required for a property purchase.

For those who find it daunting

If buying a rental property feels like an impossible task, the advice is the same as for someone looking to buy a property just to live in. Find out what your capability is. How much can you borrow? What do the repayments look like?

What you think can and can’t be done might be outdated. You should talk to someone and literally find out. You might be right. You probably will be. But you might be quite wrong too.

Campbell has had people come to him feeling meek and mild about the rental property idea. He looks at their numbers and wonders why they haven’t done this 10 years ago. They have so much capability.

“You don’t know what you don’t know, so you should find out.”

It’s a good starting point. You can start getting your bank affairs in order for what the bank is going to want to see. Get your financial accounts in order. Make sure they’re up to date. Then the numbers can be crunched.

Start early

The most important piece of advice is to start early. Knock on the door early. Don’t ring up two days after you’ve seen the property you want.

You need to get yourself into a position where you’re asking those questions three to six months before you do it. That gives time to iron out any wrinkles.

Whether you’re buying rental property or owner-occupied property, when you want to go, you want to go. When the real estate agent has an agreement out of you, it’s time to move. You want to make sure you’re totally prepared because the process is stressful enough as it is.

If you’re prepared and ready and know what you’re doing and why you’re doing it, there’s still a process to go through, but it’s relatively smooth. The biggest thing you’ll be doing is waiting. But you’re ready and excited to go.

This article and podcast is proudly brought to you by Gilligan Sheppard, the problem solvers in business who believe in thinking differently.