By Michael Beresford
Have you heard the story of the two-tradies, sitting side by side in a bar having a chat over a good old Carlton Draught? One can be overheard saying to the other, “My accountant’s a genius. He managed to get my income down to only $20,000 a year, which meant that I only paid a couple of grands’ worth of tax!”
Over the years this has been a very common scenario that I’ve heard from self-employed people believing the most significant financial outcome they’ve achieved was reducing their taxable income to the point where they’re only liable for a small amount of tax. Let me start by saying that I love seeing people have a go and I love seeing people be successful in business. However, the main challenge I’ve seen self-employed people face is their ability to borrow and therefore be able to create wealth outside their business.
SELF-EMPLOYMENT AND FINANCE
Obtaining finance when you’re self-employed is no mean feat. While PAYG employees have it fairly simple (relatively) in terms of getting a loan, the lending landscape is much harder for self-employed people to navigate. Generally, the PAYG employee will have access to nearly all the lenders, and will require last year’s group certificate, two or three payslips, maybe a Medicare card and a driver’s license, which is fairly straightforward. The self-employed applicant, however, will probably need to provide financials, disclosure on all other entities that may have cash flow running through them (for example, personal tax return, trust returns and deeds, partnership agreements and so on). Finally, assuming you have all this paperwork together, which is a challenge in itself for a new business person, you have a limited number of lenders that will consider the application and greater scrutiny put on your application by these lenders. Let’s have a look at some of the challenges and potential solutions for the self-employed.
The major challenge self-employed people face is the requirement for two years of financials. It can be up to three years, or more in some cases, until a self-employed applicant approved for a loan. That’s a long time to wait when you want to buy a house! Mostly the issue I see, however, is the way their books are done. Good accountants can be worth their weight in gold to your business and your tax strategy, but many believe they’ve done a good job simply by reducing the amount of tax you pay. Whilst I agree that you never want to be paying more tax than you need to, it’s important to understand that purely reducing your taxable income, while it might save you a few thousand dollars in the first year or so, is going to significantly affect your ability to buy a property and even more so grow a portfolio.
For example, one of the statements I hear frequently from self-employed potential investors is: “I’ve asked different banks what they can do for me as a self-employed applicant and I seem to get a variety of different answers. So, I’m just really confused.”
I can understand where that comes from because one of the big four banks will actually allow borrowing on only one year of financials while another will consider one year of financials provided they’ve been able to see the previous years and, depending on the quality of the applicant and/or the profession that they’re in, may be willing to lend on one year of financials alone. Many banks will take the average income of the last two years of financials. So, if you’ve had a bad year followed by a good year, you’re not actually able to take advantage of all the income generated in the good year of trading. Confused yet? Some banks will consider the best year of those two and others will consider the lowest year and consider the second year on a 20 per cent income higher than the lowest year, provided you can demonstrate the ability to pay the loan and depending on the strength of the case you put forward.
So, clearly there’s a complex web to be navigated here by the self-employed. It hasn’t always been this hard though. In the past, low-doc loans have been the saviour of self-employed applicants, and while they still exist, they’re not as prevalent. These days, for a low-doc approval, banks will generally require financial statements for the full year, statements proving cash flow between any entities and probably BAS statements as well. You’ll likely require a larger deposit, because the loan-to-value ratio will be lower and interest rates will be higher – as a standard rule about one per cent above your standard discounted home loan rate. So, while they’re still around they require a lot of extra effort from a paperwork perspective and the scrutiny placed on these loans is much higher.
Having said all of this, don’t be deterred. While there’s a lot of product offerings and lenders to navigate with self-employment, try to use this to your advantage. Understand a bank’s requirements and compile the best application possible.
As I wrote in a previous article about the APRA changes that have been implemented, different banks will have an appetite for certain types of lending. Be persistent and don’t take no for
an answer. Be prepared to do the research to find the best fit (or engage a competent broker, and there are many who’ll specialise in helping self-employed applicants) and understand which banks
require what documentation to strengthen the case you can put forward.
Most of all, like anything when it comes to property investment, make sure you’re educated upfront. Not disclosing any income on your financials makes finance impossible.
Understand that you’ll probably need to pay more tax than you’d like over a couple of years to be able to demonstrate solid borrowing capacity.
To the self-employed readers out there, well done for going out on your own. Business can be a challenge but very satisfying. Hopefully this helps to clarify the complex landscape that is self-employed lending. Be proactive and transparent with your accountant. This will help them understand your goals and ensure they’re aware well in advance that you want to borrow money to get into the property market or grow your portfolio so the financials can be structured the right way. Happy investing.
This article first appeared in API Magazine, to read more like this pick up the latest copy today.