How Lenders Calculate Self-Employed Income

Method one: averaging two or three years

The most common approach. The lender adds your last two or three years of net profit or salary plus dividends and divides by the number of years. It is straightforward and it suits a stable business.

Worked example: profits of 40,000 and 60,000 average to 50,000. At a typical 4.5 times multiple, that is around 225,000 of borrowing.

Method two: the latest year only

Some lenders will use your most recent year where income is rising, which helps a growing business considerably. Using the same figures as above, 60,000 assessed at 4.5 times gives around 270,000, a difference of 45,000 on the same accounts.

Where income has fallen, most lenders switch to the opposite rule and use the lower or latest figure, so a declining trend is the hardest pattern to place.

Method three: salary plus dividends

The default for limited company directors. Lenders add the salary you paid yourself to the dividends you declared, usually averaged over two years. Directors who deliberately draw little and leave profit in the company often look far poorer on paper than they are.

Method four: salary plus retained profit

A smaller group of lenders will instead add your salary to your shareholding percentage of the company net profit, whether or not you drew it. For a director who takes 12,570 of salary and 20,000 of dividends while the company retains 80,000, this can move assessable income from roughly 32,000 to over 90,000.

These lenders normally require you to hold a significant shareholding, typically 20 to 25 per cent or more, and will want accountant-certified figures.

What gets added back and what gets deducted

Beyond the headline figure, lenders adjust for a number of items. Knowing these prevents unpleasant surprises at underwriting.

• Directors loan repayments and outstanding balances are usually deducted or questioned
• One-off exceptional costs can sometimes be added back with accountant confirmation
• Depreciation is occasionally added back by more flexible lenders
• Pension contributions made personally may reduce assessable income with some lenders
• Business borrowing repayments may be treated as commitments where the business cannot clearly service them