There is an exciting point in every young (or not-so-young) adult’s life when they are looking to purchase their first property. After years of hard work, calculated networking, and generally trying your best to win at capitalism, finally, FINALLY, you are in a position to buy your first home.
And then the bank tells you that because you are self-employed, they won’t finance you.
Talking from personal experience, as a small business owner myself, this is exactly what happened to me after I had saved up enough to put a deposit down on my first home. Fortunately, I am now a proud owner of a (very modest) three-bedroom apartment (with an office, where I am now writing this article). If I can manage to get a mortgage, then I’m sure that you can too.
Some of the tips in this article may also be useful for anyone looking to get a loan. So without further ado, let’s talk about how you can hoodwink, um, I mean, convince a bank to give you, the self-employed individual, a mortgage.
The first question you will be asked is how long you’ve been running your own business (or freelancing contract, or gig-worker side hustle). Most banks like the two-year mark. If you can prove that you’ve been able to draw a regular income for at least two years, then they are more likely to talk to you.
You can’t start being self-employed and then walk into the bank and ask for a loan. Unfortunately, it doesn’t matter even if you’ve saved up a big deposit — if you don’t have the historical records of being self-employed, you can’t apply for a mortgage/loan.
This is in stark contrast to employees, who can just waltz into the bank with a payslip and call it a day. We self-employed types need to show that we can earn our keep for at least two years.
Since we’re not working for a big corporation (or big gov), we don’t have payslips to show that we’re earning income. In my experience helping my self-employed clients apply for mortgages, these are the documents needed:
If you have been in business for less than two full years (no half-years here, please), the bank may ask you to produce a ‘cash flow forecast’, prepared by your accountant. This will help show the bank that you’re in a position to make money in the near future.
In most cases, talk to your accountant and tell them that you need a ‘forecast for the bank’. A good accountant will know exactly the type of forecast you need. So far, I’ve not had a single bank turn down a client based on a forecast that I’ve made – so there is an art to this. Don’t try preparing this forecast yourself, as the banks won’t trust you to self-forecast.
There are alternatives to preparing a forecast. If, for example, you are doing contract work for a large and wealthy client (like big corps or big gov), you can produce your contract with your client and use that in lieu of a payslip or forecast. I’ve known this strategy to work with some of my clientele.
Did someone say ‘creative accounting’?
In all seriousness though, there is an art to presenting your financials so that they look good to the bank. In most cases, I can usually tell a client if their current business performance is good enough for the banks to lend to them. If not, then there are some things that you can do to look ‘financially attractive’:
Banks are very reluctant to lend to individuals with any form of debt, unless you’re in the US, where I hear that if you don’t have debt, you can’t take on debt (huh?). Banks in other parts of the world tend to take the more practical view of ‘more debt = more bad news’.
A bank said no to me one time because I had the small business cash flow loan from the IRD (which was to help with COVID issues at the time). If you have debt, you should take steps to reduce it. If you can’t effectively reduce it to a smaller amount, shop around — talk to several banks and see if they will take you on with your current debt load.
You know how your business has a profit and loss account? Your bank will want that. No misrepresenting transactions or under-reporting expenses here!
But you can hold off on spending in the years you know will be up for scrutiny. Don’t commit to the expensive big tech subscription in your first two years of business. Save on office rent, work from home. No, you don’t need an expensive business coach when starting your business — that can wait until after the mortgage. It’s these little things that add up, and if you subtract them, your profit will grow larger.
It goes without saying that you should also be making sales, and increasing your revenue will increase your profit.
The banks will want to look at your average monthly household spending. It is here that I find PocketSmith a powerful tool. When our bank asked for our monthly household spending, I simply had to export our household income and expense report for the last year and send it to our banker. Done. Sorted. If you’re already using PocketSmith, you’ve got this — no need to stress.
If you’re not using PocketSmith, then you’ll have to start going through your bank statements and categorising your expense transactions to build a picture of your household spending. You can try and ballpark the figures, but a well-put-together report is preferable to calculations done off the back of your hand.
You have to accept that gaining a mortgage while self-employed is always going to be challenging. Salaried individuals have it way easier than we do. I want to highlight some of the common issues that we can face while applying for a mortgage and how to overcome them:
This is an issue for seasonal or gig workers. Your income varies from time to time. Banks generally prefer stability in income because stable income means a better ability to repay the loan. The workaround for this is to have as much data on your earnings over a period of time.
This directly feeds into the earlier point I made about banks wanting at least two years’ worth of financial data. You can be a bit creative here and select the 24 months of financial data where you made the most sales to form your average.
Something salaried workers never have to worry about. Business performance does not necessarily correlate with personal affordability. For example, Gina runs a retail business that turns over $20,000 each month, but her running costs amount to $17,000; thus, her profit is only $3,000. Gina has to make some sacrifices when it comes to paying herself.
At the top level of performance, things can look good. But once costs are factored in, the business owner can be in a rough spot. The best way to overcome this issue is to ask yourself: How much can I afford in monthly mortgage repayments, apart from minimising costs in your business?
This is perhaps something we share in common with salaried workers. Technically speaking, a salaried worker has one big client that pays for everything, whereas business owners have several clients that pay them. Business performance can look good for the two years that your big client is paying you, but you need to consider whether your business can survive without the big client.
Fortunately, banks tend to ignore this sort of thing. But you really need to consider this if you want to service your loan. To be fair, this is something that salaried workers need to worry about, too. To overcome this, try to canvas for more clients. Don’t put all your eggs into one basket!
Being self-employed is challenging, but it sure is rewarding. While banks tend to give salaried folk an easier time, just remember that by the end of the day, you have more control over your financial future than an employee who is reliant on one client for financial stability.
Once you have been approved for your first mortgage, the subsequent ones are easier to apply for. Applying for small business loans is easy compared to getting that first mortgage. You will also have years of financial data showing that you are running a stable business that has successfully serviced your mortgage.
So stay self-employed, stay focused on your financial goals, and most importantly, stay positive!
Sam is the director of SH Advisory, an online accounting firm for small businesses and startups in NZ. He is also the creator of The Comic Accountant, an internationally-read finance comic blog. With 15 years experience in accounting and finance, he loves sharing quality financial advice with small business owners everywhere. In his spare time, he likes to nerd out over the latest board game launches and great PC gaming deals online. If you need help with your small business and startup, Sam is the person you want to talk to!
