Mortgage income - Self employed (PAYE + Dividends) vs Employed (PAYE)

pat32

Hi,
I am looking to understand how mortgage lenders assess income and therefore affordability and decide on the value they will loan. Ideally I am looking to hear from those in the business i.e. brokers, underwriters or people that work for mortgage lenders as I am confused really and so just looking to understand if my understanding is correct and if so why?

Basically as a company director your income can be made up of PAYE (income tax and NI) and dividends (dividend tax) which both attract different levels of tax.
As an employed person you are paid PAYE and all your income attracts income tax and NI.

So two different situations where there are different amounts of tax paid and so therefore the Net income is different even if the gross is the same i.e.
Person A - A PAYE employee earning £40,000 takes home £30,841.80.
Person B - A director earning £40,000 where £12,000 is PAYE and £28,000 is dividends takes home £37,683.34.
This equates to the director taking home £6,841.54 more based on the same income which equates to 22% more than the employed person.

UPDATE: To further clarify these two fictional situations are to be considered as two separate people not a single person considering different mechanisms of paying themselves. I.e Person A is employed and therefore is paid as PAYE. Person B is a company director and paid via PAYE and dividends.

So my question after all that is why is it that the gross income is used in the mortgage calculation when the net is so vastly different?
Also please let me know if I am wrong and it is the net income used. In my experience it seems this is not the case which is why I have come to this conclusion but could be wrong.

I understand these are not the only ways people are paid and there are tax free amounts but just for the sake of of this post these are the considerations.

Peter74

I would suggest gross income is for the initial decision in principle.  Being a director they'll then request SA302s or an accountant's cert showing PAYE/dividends paid.  They'll know exactly what your net income is.

917700

Firstly, I need to point out an error on the your calculation based on 12,000 Salary plus 28,000 on dividend. If you want to draw 28,000 dividend from the company, you need to have 35,000 net profit and pay 20% corporation tax first, then pay 7.5% tax on the taxable dividend. 

For most of lenders, you will not be considered as an employee if you hold more than 20% - 25% share of the limited company. 

917700

917700 said:

Firstly, I need to point out an error on the your calculation based on 12,000 Salary plus 28,000 on dividend. If you want to draw 28,000 dividend from the company, you need to have 35,000 net profit and pay 20% corporation tax first, then pay 7.5% tax on the taxable dividend. 

For most of lenders, you will not be considered as an employee if you hold more than 20% - 25% share of the limited company. 

If you are on the higher income rate band, you need to pay more tax on the dividend.

pat32

Thanks 917700,
Yes I am aware of that and it is not an error as I am just comparing two incomes not the companies income needed to pay it. The 7.5% dividend tax is included in the calculation.

Basically I am just trying to understand if lenders are using gross or net income to calculate their lending amounts as they can be vastly different.

917700

pat32 said:

Thanks 917700,
Yes I am aware of that and it is not an error as I am just comparing two incomes not the companies income needed to pay it. The 7.5% dividend tax is included in the calculation.

Basically I am just trying to understand if lenders are using gross or net income to calculate their lending amounts as they can be vastly different.

So let’s calculate in a different way. For example, let’s assume your company will make £40,000 net profit (before the salary for yourself)

Option 1 is pay £40,000 to your self via PAYE, your gross income is £40,000 and you take home £30,841

Option 2 is pay £12,000 to your self via PAYE, then you pay corporation tax (£40,000 - £12,000) X 20% = £5,600. So you can only draw £22,400 dividend. Then, you need to pay tax on taxable dividend.

Your gross income for option 2 is £34,400 and your can take home £30,870 (£12,000 plus £ 18,870).

dunstonh

So my question after all that is why is it that the gross income is used in the mortgage calculation when the net is so vastly different?

Don't forget that retained profits (and retained profit trend) is taken into account. 

You have also disregarded corporation tax.   Dividends are paid out AFTER corporation tax.  Salary is a business expense and reduces corporation tax.   So, you are missing a big chunk of money in your comparisons.   Lenders take that into account.

Basically I am just trying to understand if lenders are using gross or net income to calculate their lending amounts as they can be vastly different.

For self employed they look at turnover, gross profit and net profit.

For limited companies, it is turnover, profit before tax, profit after tax, retained profits, salary & dividends.

pat32

917700
That is not my question. Thank you for replying but I would like to stick with original question and examples.

917700

pat32 said:

917700
That is not my question. Thank you for replying but I would like to stick with original question and examples.

Sorry, I read your original post again and I realize you are comparing two different people.

I don’t know the answer for your question, but there are many difference for employee and self employed person. Self employed person has higher risk than the employees 

pat32

Thanks 917700,
Yes sorry I realised it was maybe not as clear as I intended so I updated it a little.
Yes I know that is what is said with regard to risk however it confuses me as how is someone that is employed by a self employed person less risky? I know not that is not always true but in a lot of cases an employee is working for a self employed person but seen as less of a risk than their employer!

MWT

pat32 said:

Yes I know that is what is said with regard to risk however it confuses me as how is someone that is employed by a self employed person less risky? I know not that is not always true but in a lot of cases an employee is working for a self employed person but seen as less of a risk than their employer!

Because as a business owner taking a significant potion of your income from dividends which in turn require profits, the profits can go all the way down to zero without affecting your ability to make payroll for your employees, but zero profits means a huge cut in your own personal income...

That is why the lenders are very interested in profit performance over time, and why it is so much harder to get a mortgage as a business owner if you don't have a decent number of years to show...

Somewhat over-simplified of course, but you get the point I hope. Salaried employees are part of your fixed-costs. dividends are much more sensitive to profitability.