Applying for a home loan is stressful for most people, but this simple financial process can become disproportionately complex for entrepreneurs or freelancers ‒ people who have uncertain or unpredictable income flows. The rigorous affordability assessments required by the National Credit Act don’t quite take into account the circumstances of those not earning a regular monthly salary. However, not all hope is lost.
Careen McKinon, provincial sales manager at bond originator ooba, says the home loan application process requires a little bit more effort when you are self-employed or a freelancer, as the banks look at you as a higher risk. “The lack of a guaranteed income from a single source can make banks anxious about financing a home for you,” she says.
According to ooba, 10% of home loan applications received in the third quarter of last year were from self-employed applicants, compared to 11% in the second quarter of last year and 9% in the third quarter of 2014. This is about half of the 20% level experienced in 2007, indicating that self-employed applicants are generally less confident about their ability to qualify for home finance.
Freelancer Sue Charlton says she was able to qualify for a home loan. “If you ignore the pointy-down faces of estate agents and bank personnel and get your financials from a tax person/accountant, supply your banking details, assets and liabilities and statements, it’s not too bad. My experience is that I have not had too bumpy a ride despite the pessimism of some,” she says.
McKinon says if you do your homework, as with any other bond application, you can increase the chances of your home loan being approved.
Steps for the self-employed
The first step is to ensure that all your paperwork is in order. If you are self-employed, McKinon suggests that you submit the following when applying for a home loan:
- Comparative financials covering a trading or working period from the last two years.
- A letter from your auditor confirming your personal income.
- If your financials are more than six months old, you will need up-to-date signed management accounts.
- A cash flow forecast for the next 12 months.
- A personal statement of assets and liabilities.
- Personal and business bank statements (six to 12 months, depending on the banks’ requirements).
- Latest IT34, which serves as confirmation from SARS that your tax affairs are in order.
- Company, CC or trust statutory documents.
- ID documents for all the directors, members or trustees.
Although this list seems rather daunting, it is all the more reason to use an expert to guide you through the process, as this will get you one step closer to acquiring a home loan. “It is imperative to have your tax affairs and finances in order and up to date. In addition, it will help to separate your personal and business expenses,” says McKinon.
She says that self-employed applicants generally undergo a longer home loan approval process than individuals who are not self-employed.
Steps for freelancers
But what happens if you are a freelancer, ie, you earn income from one or more sources and your income fluctuates from month to month or even every six months? Steven Barker, head of home loans at Standard Bank, says in general a freelancer would need to show a track record of an income ‒ bank statements can usually prove this.
“The problem is that most freelance contracts run over the short term. When it comes to applying for a home loan, the longer your freelance contracts are, the better,” he says.
Just as self-employed individuals need to tick certain boxes to meet banks’ requirements, there are a few things that a freelancer can put in place to ensure that their home loan application is viewed favourably:
Prepare abridged financial statements
A freelancer is treated as a sole proprietor, although they are not required to have full annual financial statements. McKinon says most of the banks will require you to cumulate your income (add up your income from various sources), and prepare an abridged version of an annual financial statement. “The annual financial statement will need to include at least an income statement and balance sheet which should tie into the applicant’s personal annual tax return (the ITa34),” she says.
The income statement and applicant’s personal annual tax return are the best documents to present to the bank, as your income fluctuates month on month and an annual snapshot is more favourable for a freelancer. Based on the financial data housed in the income statement, the bank is able to see the freelancer’s income and cross-check this with their annual tax return.
Build up a deposit
If you know you want to buy a property at some stage, one of the best moves you can make as a freelancer is to start saving towards a deposit. Barker says the home loan application process instantly becomes smoother once the bank sees that you have saved up a deposit, reducing the risk that the bank is taking on. Ideally, you would have a bigger deposit than a typical home loan application. Instead of a 10% deposit, work towards a 20% deposit so that the bank only takes on 80% of the loan-to-value risk. “A large deposit undoubtedly weighs the odds in your favour,” Barker says.
What about surety?
Is surety an option? “Only as a last resort and even then, we are moving away from the surety model,” Barker says. Typically, a family member or spouse would offer suretyship and the banks tend to prefer a joint ownership structure rather than surety. When someone stands surety for you on a loan, it means that they are undertaking to repay the loan if you default or are unable to meet the loan repayments. Previously, this was the equivalent of standing guarantor on your loan. However, under the National Credit Act, standing surety for someone on a loan has taken on greater significance and can now affect your own affordability assessment.
McKinon says the implication for the surety applicant is that they will be 100% liable, and should they apply for any lending in the future, this mortgage will appear as their liability and may impact future lending. Also, should the primary applicant default on the mortgage, the surety will be accountable to service the debt.
For example, let’s say Ms Smith wants to take out a R1 million home loan and her brother, Mr Smith decides to stand surety for her. A year later, he wants to take out his own home loan for R2.5 million but the surety stands on his credit profile as though he has taken out the loan himself and this will be taken into account when the bank is carrying out an affordability calculation.
Register a company
A freelancer could opt to register a company and build up two to three years of financial records. However, Barker warns that this can become expensive. “It’s a very formal arrangement that can have positive spin-offs in the long run, but it should be done with a broader view than simply wanting to access credit,” he says.
“Ultimately, a freelancer wants to be in the position where they have multiple contracts with different clients, where they have built up track records and can assure the bank of future income streams,” he concludes.