Self employed home loans
Self-employed home loans explained
As the gig economy grows, more Australians than ever are freelancing, contracting, sole trading and running their own businesses. If you fit into any of these categories, you might be considering a self-employed home loan. Read more about how self-employed home loans work and what to look out for when you’re comparing them in this comprehensive guide.
How do self-employed home loans work?
You may have heard that sole traders and small business owners used to struggle to get home loans in the past. Because self-employed people didn’t have regular payslips and often had fluctuating income, lenders usually deem them to be riskier borrowers.
However, as more people became self-employed, lenders altered their application processes to accept other proof-of-income documents. Low-doc products have also become widely available. Which product is most suitable for you depends on how long you have been self-employed.
If you’ve been self-employed for over two years, you can apply for most home loans that are available on the market. To prove your income, you’ll need to provide two years’ worth of tax returns for yourself and your business. This is known as a full doc home loan, which essentially functions in the same way as any other standard home loan.
If you’ve been self-employed for less than two years, you probably won’t have the required tax returns for a regular home loan application. Instead, you can apply for a low-doc home loan using alternative documentation. You still need to provide your ID and asset and liability information.
To prove your income level, the lender may ask you to supply any combination of these documents:
- Personal and business tax returns
- Business Activity Statement certified by the ATO
- Bank statements going back six months
- ABN registration information
- GST registration if you earn over $75K a year
- Certified document, signed by you, declaring your income
- Letter from your accountant
It’s important to note that low-doc loans are considered to be a higher risk for most lenders, so they can be more expensive than regular loans. Generally speaking, the interest rate on low-doc loans is usually 0.5%-1% higher than full doc loans.
Currently, the big 4 banks aren’t offering low-doc loans, but there are plenty of online lenders who do. In fact, some online lenders have low-doc products that are specifically designed for self-employed people, so it’s worth shopping around.
How do interest rates work on self-employed home loans?
Most lenders will offer the same rates to self-employed people that they would offer to anyone else. This means you have the option of a variable, fixed, or split interest rate.
Variable rate self-employed home loans
Variable rates are constantly changing to reflect market movements. If rates drop, a variable rate self-employed loan will become much cheaper. On the other hand, if rates rise, your interest costs will go up. For this reason, variable rate mortgages can be hard to budget for.
They do, however, offer you flexibility. There are usually no restrictions on extra repayments, which means you can pay off your loan faster and save a lot of money. There are also no lock-in contracts, so if you find a great deal with another lender, there are no penalties for switching.
Fixed-rate self-employed home loans
Fixed-rate home loans have set regular repayments. If, like many self-employed people, you find your income varies from month to month, a set repayment can really help you to budget.
On the other hand, fixed-rate home loans tend to be less flexible than their variable counterparts. Many lenders impose limits on extra repayments and redraws. If you would like to pay a little more towards your mortgage when business is booming, and a little less when things are tight, then a fixed-rate loan may not be the best option.
Split-rate self-employed home loans
A split-rate loan divides your home loan into a variable component and a fixed component, giving you the best of both worlds.
When interest rates rise, it will only affect the variable part of your loan. The fixed component remains unchanged, which helps you keep your costs down. On the other hand, when interest rates fall, the variable component lets your take advantage of the cheaper rates.
It’s important to note that fees are payable on your home loan in addition to interest, splitting your home loan into variable and fixed components means that you’ll have to pay fees on both.
What are some of the features I should look for on a self-employed home loan?
If your income fluctuates a bit from month to month, having some flexibility with your repayments can really help you stay on top of things. Here are some of the features that can help:
Extra repayments
If business is booming and you have some spare cash, making extra repayments is a great way to cut your mortgage costs. On a variable-rate loan, you can usually make as many repayments as you like. However, extra repayments can be restricted on fixed rate loans and are likely to come at the cost of a fee.
If you are interested in a fixed-rate loan, look for a lender that offers extra repayments as a feature. Check how many extra repayments you can make, if there is a limit to how much you can pay off and if any fees are involved.
Redraw facilities
When business slows down, you might find yourself in need of extra funds. If your home loan offers redraws, you may be able to take money from your loan.
It’s important to note that redraws are not available for your regular repayments. Rather, they allow you to take back any extra repayments you’ve made. You will need to apply to the lender each time you need a redraw and there may be a fee involved.
The main thing to remember is that every time you redraw funds, your loan gets bigger. If you are an impulse spender, then having access to redraw your repayments may not be the best option.
Offset accounts
Offset accounts give you control over your cash flow and can save you a lot of interest. You can add to and withdraw funds from an offset account whenever you like, without any approvals necessary. Usually, you’ll be given a debit card that you can tap as you go.
The best thing about offsets is that the money in the account is put towards your mortgage so that you pay less interest. For example, if you have a $200,000 mortgage and $20,000 in the offset account, you’ll only pay interest on $180,000.
There may be a small admin fee involved for running the offset account, but if you use it wisely, your interest savings should more than make up the costs.
How big a deposit do I need for a self-employed home loan?
The standard home loan deposit is 20%. However, depending on your work situation, the lender may ask you for a bigger or smaller deposit.
Full doc loans
If you have been self-employed for more than two years, and are applying for a full-doc self-employed loan, you can get a mortgage with a deposit as low as 5%. Because the lender is putting up 95% of the cost, they are taking on more risk, and so they will charge you a higher interest rate.
You will also need to pay for Lender’s Mortgage Insurance (LMI) so that the lender is covered if you default. Some lenders don’t use LMI and instead charge a risk fee. The risk fee isn’t included in the comparison rate, so be sure to look out for it in the fine print.
Low doc loans
If you have been self-employed for less than two years and are applying for a low-doc loan, the lender will usually require a deposit of 20%-40%. For lenders, low-doc loans are already risky, so their LVR restrictions limit how much money they will loan you.
You may find some smaller lenders online who will lend you up to 95% of the property value, but they will usually charge you high interest rates and fees.
In general, we recommend you put down as big a deposit as you can afford, because it can save you tens of thousands of dollars in the long run. You can see this in the table below where we’ve taken the example of a property worth $800,000. The interest is 2.4% and the loan is to be paid over 25 years.
| Deposit | Loan amount | Monthly repayments | Monthly repayment savings compared to 5% deposit | Total interest paid | Interest savings compared to 5% deposit |
|---|---|---|---|---|---|
|
5% |
$760,000 |
$3,371 |
N/A |
$251,402 |
N/A |
|
10% |
$720,000 |
$3194 |
$177 |
$238,170 |
$13,232 |
|
15% |
$680,000 |
$3,016 |
$355 |
$224,938 |
$26,464 |
|
20% |
$640,000 |
$2,839 |
$532 |
$211,707 |
$39,695 |
|
30% |
$560,000 |
$6,242 |
$976 |
$185,243 |
$66,159 |
|
40% |
$480,000 |
$2,129 |
$1,242 |
$158,780 |
$92,622 |
The table shows that the bigger your deposit is, the less interest you’ll pay over the life of your loan. In fact, in this situation, having a 20% deposit instead of a 5% deposit could save you $40K. Lenders also view borrowers with big deposits as low risk and offer them lower interest rates so you could potentially save even more.