Self-employed borrowers represent a growing segment of the Australian mortgage market, yet assessing their income remains one of the most complex tasks for brokers. Unlike PAYG employees with straightforward payslips, self-employed applicants require careful analysis of tax returns, financial statements, and business structures.
Understanding Business Structures
The first step in assessing a self-employed borrower is understanding their business structure, as each has different implications for income calculation:
Sole Traders The simplest structure. Income is reported on the individual's tax return, and the business income is the person's income. Look at: - Business income on the individual tax return - Schedule of business expenses - Net business income after legitimate deductions
Companies (Pty Ltd) Company structures separate business and personal income. You will need: - Company tax return - Individual tax return showing salary/wages and dividends - Company financial statements (profit and loss, balance sheet) - Director loan accounts
Trusts Trust structures can be complex, with income distributed to multiple beneficiaries. Required documents include: - Trust tax return - Trust distribution statement - Individual beneficiary tax returns - Trust deed (in some cases)
Partnerships Similar to trusts, but with specific partnership agreements governing income splits: - Partnership tax return - Individual partner tax returns - Partnership agreement
Key Addback Items
Lenders recognise that certain expenses reduce taxable income but do not represent actual cash outflow from the business. These "addback" items are added back to the declared income to better reflect the borrower's true earning capacity.
Common addback items include:
- Depreciation and amortisation: Non-cash expenses that reduce book profits
- Interest on business loans: Often added back when refinancing will change the debt structure
- One-off or extraordinary expenses: Costs that will not recur
- Personal superannuation contributions: Made through the business but benefiting the individual
- Motor vehicle expenses: Where the vehicle has personal use component
**Items that typically cannot be added back:** - Wages paid to employees - Rent and occupancy costs - Cost of goods sold - Insurance premiums - Regular operating expenses
Calculating Assessable Income
Most lenders use a two-year average of income, though some will accept a single year if income is trending upward. Here is the general approach:
For Sole Traders 1. Start with net business income from the tax return 2. Add back applicable items (depreciation, one-off expenses) 3. This gives the adjusted business income 4. Average across two financial years
For Company Directors 1. Take the director's salary from the company 2. Add dividends paid to the director 3. Add the director's share of retained profits (varies by lender) 4. Apply addbacks to the company profit before calculating the share 5. Average across two financial years
For Trust Beneficiaries 1. Start with the trust distribution to the borrower 2. Some lenders add back the borrower's proportional share of trust addbacks 3. Consider retained earnings policy (varies significantly by lender) 4. Average across two financial years
Lender Variations
One of the biggest challenges with self-employed assessments is that every lender has different policies:
- Major banks tend to be conservative, often requiring two full years of tax returns and using the lower of the two-year average or most recent year
- Non-bank lenders may be more flexible, sometimes accepting one year of returns or using alternative documentation
- Specialist lenders may offer low-doc or alt-doc products for borrowers who cannot meet standard documentation requirements
Understanding these variations is crucial for finding the best fit for your self-employed clients.
Common Pitfalls
**1. Not requesting all required documents upfront** Self-employed applications require significantly more documentation. Create a comprehensive checklist for your clients early in the process.
**2. Overlooking the GST impact** Ensure income figures are GST-exclusive when required by the lender.
**3. Ignoring declining income trends** While a two-year average may produce a favourable number, many lenders will decline if income is trending downward.
**4. Not accounting for personal use adjustments** Some expenses claimed as business deductions have a personal use component that lenders may not add back.
How Technology Can Help
Manually analysing tax returns and financial statements for self-employed borrowers is complex and error-prone. AI-powered tools can:
- Automatically extract key figures from tax returns and financial statements
- Calculate addback items according to individual lender policies
- Compare the borrower's profile against multiple lenders simultaneously
- Flag inconsistencies between related documents (company return vs individual return)
- Track income trends across financial years
By automating the number-crunching, brokers can focus their expertise on finding the right lending solution and structuring the application for success.
Conclusion
Self-employed income assessment requires specialised knowledge and careful attention to detail. By understanding the different business structures, knowing which items can be added back, and staying current with lender policies, brokers can confidently serve this growing market segment and help more Australians achieve their property goals.