Getting a mortgage using your company’s retained profits

First, what are retained profits?

When your limited company makes money, you have a choice. You can take the profit out as salary and/or dividends (a dividend is a payment made to the owner of a company from its profits). Or you can leave some, or all, of the profit inside the company.

The money you leave in the company is called retained profit (sometimes called retained earnings). Many directors do this deliberately, for two main reasons:

• Tax efficiency: Taking money out of your company means paying personal income tax. Leaving it in the company means you only pay corporation tax, which is often lower than personal tax. You can then choose when — or whether — to draw down that retained profit later.
• Business security: Maintaining a financial cushion gives your business flexibility.

These represent sensible financial planning strategies. But they can create a problem when you apply for a mortgage.

Why most banks give you less than you deserve

Imagine your company makes £100,000 profit each year after deducting your salary, but before corporation tax. You pay yourself a salary of £12,500 and take dividends of £37,500.

For mortgage purposes, many traditional lenders will look only at your personal income, i,e, your salary and dividends. In this example, that would be £50,000.

However, this does not necessarily reflect the company’s full profitability. After corporation tax, the company may still have substantial retained profit, which you have chosen to leave inside the business rather than withdraw personally.

By way of example, if the company makes £100,000 profit before corporation tax, and corporation tax is approximately £22,750, the company’s post-tax profit would be approximately £77,250. If you then take dividends of £37,500, approximately £39,750 would remain inside the company.

Some specialist lenders will take this retained company profit into account when assessing affordability. Instead of looking only at salary and dividends of £50,000, they may consider a broader measure of income, such as salary plus the company’s post-tax profit.

In this example, that could be:

This can produce a much stronger affordability position than a lender who looks only at salary and dividends. The exact treatment will depend on the lender’s criteria, but using retained profits can, in appropriate cases, significantly increase the borrowing available to a company director.

Using this affordability calculation could allow you to borrow significantly more, in some cases twice as much.

Is a "retained profit mortgage" even a thing?

Technically, there’s no such thing as a retained profit mortgage product. It’s simply the way that certain lenders choose to calculate your earnings when deciding how much to lend you.

Most traditional lenders use: salary + dividends. A small number of lenders—traditional lenders with specialist underwriting teams, and specialist lenders in their own right—instead use: salary + company net profit. It’s these specialists you need access to for getting a mortgage using your retained profits.

Because dividends come out of profit, you cannot use both profit and dividends at the same time with the same lender. That would be counting the same money twice.

Who does this underwriting method benefit most?

Including retained profits in the affordability calculations is most useful for directors who:

• Pay themselves a low salary (to reduce their tax bill)
• Take some dividends, but deliberately leave a significant amount of profit inside the company
• Have been trading for at least two years, with consistent or growing profits

If you take out all of your profit as dividends each year, the difference in what you can borrow will be small. That’s because the profit and dividend figures will be almost the same. The real benefit goes to directors who keep money in the business.

How do specialist lenders work out what you can borrow?

The most common calculation specialist lenders/underwriting teams use works like this:

Your salary + your share of the company’s net profit* = your accepted income

Your share of the profit depends on how much of the company you own. If you own 100%, you use 100% of the profit. If you own 50% (for example, with a partner/business partner), you use 50%.

Most lenders then take an average of the last two years’ profits to smooth out income fluctuations from one year to the next. Once they have your income figure, lenders typically offer a mortgage of 4.5 to 5.5 times that amount.

*Net profit means post-tax profit after all business costs, wages, and corporation taxes have been paid. Most lenders use net profit after corporation tax (not operating profit), because it reflects money you could actually draw out of the business if you chose to.

What supporting documents will you need?

• Company accounts, signed off by a qualified accountant. Most lenders will not accept accounts you have prepared yourself. Equally, most traditional lenders require two years’ company accounts. The benefit of using a specialist broker like Freelancer Financials is that their lender panel can work from only one year’s accounts!
• SA302 and Tax Year Overview documents from HMRC. These are official records of your personal income and tax for each year, which you can download from your HMRC online account.
• Bank statements: underwriters usually ask for three to six months of personal statements, and sometimes business bank statements, too. These confirm your personal outgoings and verify what your accounts imply.
• An accountant’s certificate: some lenders may ask your accountant to write a formal letter confirming your retained earnings, explaining why that money remains in the business.

It’s worth speaking to your accountant early, so that they’re ready to provide these documents when needed.

Will my interest rate or the deposit I need be higher?

With a lender sympathetic to how you work, you shouldn’t pay a higher interest rate. Nor should they ask you to provide a larger deposit.

Interest rate: Lenders who use retained profits offer the same rates as those for other mortgage applicants. They shouldn’t charge you more simply because they calculate your income differently.

Deposit: Specialist lenders offer the same deposit requirements as for ‘standard’ mortgage applicants. They can lend up to 95% of the property’s value (meaning you would need only a 5% deposit), just as any other lender would. But, the greater the deposit you can find, the better the interest rate they will offer.

The only limitation is that fewer lenders offer this approach. That means you may not always have access to the single lowest rate in the entire market. A specialist broker like Freelancer Financials will find the best available rate among lenders that accept retained profits.

How many lenders use retained profits for affordability calculations?

A much smaller number of lenders are prepared to use retained profits in their affordability calculations. Even fewer will offer a mortgage based on one year’s accounts.

Some of these are well-known high street banks with specialist underwriting teams, who work from head office (you won’t access them in-branch or via call centres). Others are specialist lenders with minimal high-street presence (if any).

Even specialist lenders rarely advertise their specialist lending criteria. That’s because they rely on specialist brokers like Freelancer Financials to ‘vet’ applicants before sending them their mortgage applications. That’s why using a specialist mortgage broker is so critical for this type of application.

Why you need a specialist broker

A standard bank adviser, or a generic mortgage comparison website, won’t help your cause. They’re trained/set up to handle straightforward cases, like PAYE employees and straightforward self-employed workers.

If you approach the wrong lender, one that does not accept retained profits, they could reject your application. That rejection will immediately appear on your credit file. Multiple rejections seriously damage your credit history and make it harder to get approved in the future.

A specialist broker knows, before submitting anything, which lenders will consider retained profits and which won’t. They also know:

• Which lenders require one year of accounts, and which need two
• Which lenders average two years’ profit, and which use the most recent year
• Which will ask for an accountant’s certificate and which rely on filed accounts alone
• How to present your financial position clearly to an underwriter, who’ll make the final decision on whether to approve your mortgage or not

Freelancer Financials has been arranging mortgages for limited company directors and contractors for over 20 years. If your company has retained profits that a standard lender is ignoring, they can show you what you could actually borrow.