Borrowing capacity: PAYG vs Self-employed

Hi members,

Peter works a FT job and a self-employed job tutoring for over 3 years. Last 3 years income were 5k, 8k and 25k.

Current income: 55k PAYG + 25k Self-employed

Peter's business is growing but he reduces main job from FT to PT.

New income: 25k PAYG + 55k self-employed

He still earns the same income.

Which option gives better borrowing capacity to continue investing?

 

Assuming the self employed addbacks remain the same, the latter will be worse with some lenders due to taking the lower SE income of $25k into consideration which will lower the useable income.

Best case (assuming add-backs are the same for both scenarios) is that there is no difference. Lender choice makes a big difference here.

 

If you go with a lender that only requires one years financials such as CBA and ANZ then there won't be much of a difference. That's assuming you can provide a recent return showing net income from the biz as being $55k and a recent payslip confirming the $25k payg.

Cheers

Jamie

 

Self employed are usually at a bit of a disadvantage. SE income is only as good as the last tax return. You might be on track to make $120k this year but if last years return says $80k, then that's what you've got to work with.

Base salary is as good as the last payslip. That only gets tricky when there's bonus' commission and overtime to prove (which usually goes back to the last PAYG summary).

 

Most lenders will work on a variation of the two latest years tax returns, deriving income as either:

• the latest tax returns net income + addbacks OR
• if the latest year is more than 20% above the previous financial year, a maximum of 120% of the previous financial years net income + addbacks

There are a small number of lenders which will base it solely on the net income + addbacks of the latest financial year, but having such a smaller number of options is restrictive.

PAYG is always simplest, but self employed can be useful once you have a healthy long term trend of income.

 

This can be very useful especially that my SE income is in it's growing stage. Do most banks generally take the 120% of previous years income if the latest income is 20% more than previous years?

Thanks every, I have a better understanding of my choices now.

 

Self employed:

Self employed income is usually more backward looking - i.e. income documentation has longer timeframes, with income documentation from up to 18 months ago being used for serviceability.

You also typically need a 2 year ABN history.

Furthermore, as Corey alluded, there's plenty of lenders that will take a 2 year review of your income.

There are financing options that shorten this period (e.g. low doc financing options that use a shorter and more recent time window).

Nonetheless, with self employed income you can add back certain expenses like depreciation back into your income. So if you made 25k but had 5k depreciation expense listed on your returns, than you can add this back and have a higher income used.

Longer term, there are strategies that self employed people can use to further borrowing capacity though, particularly high income earners. There's far more control in splitting income to different parties, particularly spouses. This can be used to navigate different tax rates/purposes. Very high incomes allow these options to be taken advantage of further (e.g. having one partner as the investor and one as the owner occupier, and splitting income at different times).

PAYG:

PAYG is usually far more simple. Don't need two years of history to start using the income!

However, now most variable income types like overtime/bonuses/commissions are being shaded now, so it can work against you. Most shade this income and use 80% of it, even if you can demonstrate 2 year + history of bonuses/commissions in a regular manner.

Variable self employed income however isn't shaded, e.g. an independent contractor who earns income via an ABN in commission like manner, won't have their income shaded.

 

If one was to earn say 50k as a PAYG vs 50k income as self-employed

Would PAYG have better loan options & rates available compared to self-employed?

Hence making it better to build a portfolio as a PAYG?

 

Same

 

Income is income, however it's all about paperwork. Most banks require 2 years tax returns while a few only requires 1 year tax returns.

If there's a big variance on the last 2 years tax Returns then you might get into a bit of a pickle.

Thus long story short, with your scenario $80k income gets you the same borrowing capacity regardless of what portion PAYG or SE.

 

Thanks for replies

ok so its the basically same lending capacity/rates wise except if you need to go to low doc space because you dont have 2 years of profit on paper or 2020 was a bad year. Then things change a bit?

 

Pretty much.

 

Lo doc loans still have their own qualifying criteria, they're not a license to borrow money. Lender will use your BAS statements or other info to determine borrowing power. In many cases I've looked at lo doc options for clients and have been able to get more borrowing power out of their tax returns.

If 2020 was a bad year, get your 2021 returns done. There's plenty of lenders that will overlook a bad year if you've got a reasonable explanation and can demonstrate you've since recovered.