If you’re a business owner looking for a mortgage that utilises your retained profits, we’ve got you covered.
We have access to a team of expert brokers have a great track record of making this happen. We know how crucial it is for you to have access to your hard-earned money.
This article answers the question: Can you get a mortgage using retained profits?
We look at how retained profits are treated by lenders, with tips to help you secure a retained profit mortgage.
What are retained profits?
Retained profits can be defined as the profits that remain within a limited company after dividends have been distributed to its shareholders. This accumulated trading profit will be shown within the company accounts under ‘Profit and loss reserves’.
Shareholding directors have the privilege of deciding how much income to withdraw from the company and when. If the income is not required at that time, it can be kept in the business for future use. Shareholders are at an advantage as they don’t pay dividend tax on dividends that aren’t withdrawn.
Although it’s common for shareholders to accumulate substantial sums in their limited companies as undrawn profits, using this profit to support a mortgage application may be difficult.
Many lenders choose not to include retained profits, since there is always a risk that difficult trading periods could use up this cash.
Quick example
Understanding retained profits is essential because they provide an insight into a company’s financial health, showing how much resource it has to reinvest in growth or to weather future financial challenges.
Let’s assume you own a limited company. This year, your company has generated a net profit of £200,000 after all operating expenses, taxes, and other costs. You decide to distribute £150,000 as dividends among the shareholders, leaving £50,000 in the business.
This £50,000 is what we refer to as retained profits. These funds can then be used for any number of purposes, including reinvestment in the business for growth or to buffer against future financial uncertainties. Or it can be kept as a future dividend payout.
If you do the same the next year, without spending any of it, then the retained profits grow to £100,000. This is money that could have been legitimately distributed to shareholders.
In relation to a mortgage application, the amount of retained earnings you can use will depend on the percentage shareholding you have.
- If you own 25% of the business you can use £25,000 of retained profit
- If you own 50% of the business you can use £50,000 of retained profit
- If you own 75% of the business you can use £75,000 of retained profit
Company director income
As a company director looking to secure a mortgage, it’s important to know that some lenders will recognise the retained profits in a business as additional earnings, which will help to increase your borrowing potential.
While mortgage lenders typically assess affordability based on salary and dividends, including retained profits should lead to a larger borrowing limit. In some cases the retained profits are greater than the combined total of salary and dividends.
Are mortgages calculated on turnover or profit?
Lenders do not use business turnover in any mortgage calculations. For sole-traders and partners, the mortgage will be based on personal profit before tax, while for shareholding directors, it will be based on PAYE salary, dividends, and undrawn profit shown in the company accounts.
Mortgage availability
Getting a mortgage using retained business profits is a valid option. Self-employed borrowers often think it’s harder to obtain a mortgage, but it’s not always the case.
To access the most favourable rates, you generally need a deposit of 40% or more.
A 15% deposit is also capable of securing competitively priced mortgage rates. To increase your chances of getting a mortgage, you should use an experienced mortgage broker that specialises in helping self-employed borrowers, especially shareholding company directors.
The mortgage brokers we work with are connected to specialist lenders who evaluate your situation individually, rather than relying on automated systems like other providers. Many lenders consider retained business profits as your personal money, which can potentially increase your borrowing power.
Mortgage affordability
Lenders assess affordability based on your actual income and outgoings, including those for personal and business use. They will also consider your age, existing financial commitments (such as mortgages, student loans, credit cards, car finance, etc.), and other relevant information that may affect your ability to meet your repayments.
Affordability assessments by lenders are based on a stress test which evaluates your income and outgoings against potential interest rate rises during the mortgage term. This ensures you can pay your mortgage even if interest rates go up.
The lender needs to see that you can draw enough money from your business, including dividends and salary, to maintain your current lifestyle and financial commitments while also being able to afford the mortgage.
How much can you borrow?
To determine how much you can borrow, mortgage lenders take into account your provable income, outgoings and affordability.
Typically, lenders may use a multiple of your annual income to decide the maximum mortgage amount you can borrow. However, if you receive dividends or have undistributed profit reserves in your limited company, an experienced lender could take these into account, potentially allowing you to borrow much more.
Let’s look at a simple example:
- Limited Company
- One shareholder/director
- £9,000 PAYE salary
- £50,000 dividends
- £200,000 retained profit
The actual gross income was £59,000 (9k + 50k). These amounts were taken to minimise personal income tax but still provide for a preferred standard of living.
Most mortgage lenders would use just the £59,000 when calculating the mortgage, as this was the amount actually paid out.
£59,000 x 5 multiple = £295,000 mortgage
But a lender that understands how dividends and profit reserves work, would be able to bring in the undistributed profit. In this example the £200,000 of reserves was accumulated over the last 4 years, giving an average of £50,000 per year.
£59,000 + £50,000 = £109,000
£109,000 x 5 multiple = £545,000
In this example the maximum mortgage has been increased by 250K!
You may also have the option to use a blend of your salary and dividends/profits, based on your unique financial situation.
Proving your income
If you’re applying for a loan, you’ll need to show proof of your income. To do so, many lenders will want to see your last three years of income statements from the Self Assessment tax calculations (SA302), Tax Year Overviews (TYO) from HMRC, or trading accounts.
Sometimes, lenders may also ask your accountant to complete a certificate confirming your earnings. If the accounts or SA302 don’t clearly show the most recent income position, they may request recent copies of bank statements, both personal and business.
When lenders assess your income over a few years, the income used for the mortgage will be an averaged figure. This may cause the loan amount to decrease.
However, there is another option if this is an issue for you. You may seek a lender who looks only at your income from the past year (which hopefully is higher).
Repayment methods
Mortgages are usually set up on a capital and interest basis, where you make regular payments over an agreed term to repay the loan and interest.
Some lenders offer interest-only payment options, which could work if you need more flexibility or already have significant financial commitments.
However, remember that you’ll still need to pay off the original loan amount at the end of the term, which could mean a lump sum payment or further borrowing.
If you’re not sure which repayment option is best suited to your circumstances, seek advice from an independent mortgage adviser.
Interest rate options
When you’re applying for a mortgage, there are a few types of interest rates that you need to be aware of:
Fixed rate: You can lock the interest rate for a certain time period which means you know exactly how much you’ll be paying each month, regardless of any changes in the Bank of England’s base rate.
Tracker rate: This rate moves up or down in line with the Bank of England’s base rate. This could be a good option if you think rates might fall but remember, you’ll need to be prepared for possible increases too.
Variable rate: The interest rate on this type of mortgage can move up or down based on market conditions. It’s important to make sure you can handle increased costs if rates rise during your loan.
What options are there for bad credit?
If you have bad credit, some lenders might still offer you a mortgage, but be aware that these typically come with higher interest rates and stricter terms and conditions than standard mortgages.
To increase your chances of being approved for a mortgage, it’s important to get your finances in order. This means paying all of your bills on time, setting up payment plans where needed, and separating old debts from new ones.
To find a lender who is more likely to accept your application, it’s a good idea to work with a broker. They can help you understand your options and improve your chances of getting the best deal.
To summarise
If you have retained business profits, you can use these to secure a larger mortgage and increase your borrowing potential.
It’s important to approach a lender that understands how a small limited company works, and so is happy accepting the profit reserves as income.
If you need further assistance, we can introduce you to an award winning mortgage brokerage, who can provide a free, no-obligation consultation to discuss the best options for you.
Call us on 0330 030 5050 or click the button below.
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