29 Jun 2022

Are business loans excluded from my home loan assessment?

We understand there are many factors at play when banks assess business owners trying to apply for a home loan. One of these factors is your business loans. That is, loans in your business may impact your ability to get a mortgage for your home or investment property.

We hear a lot from business owners who say “Loans in my company don’t affect my personal borrowing capacity”. Is this true? Are business loans excluded from my home loan assessment?

Well, the answer is – it depends. Let me explain why.

How Do Loans in My Business Impact My Borrowing Capacity

Have you ever taken out a car loan for your business, or perhaps a commercial property loan, overdraft or even credit card and thought to yourself – how does this impact my ability to get a home loan?

The common mistake made by many business owners, is because the loan is in the name of their business, and their business is a separate legal entity, it does not affect their personal borrowing capacity.

While this applies in some circumstances, it does not always hold true in all cases, and it really depends on the size of the business, the number of shareholders and the bank you are applying to.

When determining how business loans impact your personal borrowing capacity, there are two approaches to this and which approach may apply to you:

  • Approach 1 “Group Assessment”
  • Approach 2 “Standalone Assessment”

Approach 1: Group Assessment

A Group Assessment typically applies to smaller businesses, especially to businesses with a sole owner.

This is when the bank combines your personal financial position, with the financial position of your business, to determine your overall borrowing capacity.

As we saw in previous videos, for a small business , the net income of the business and a director’s personal salary are so interconnected that a bank let’s a business owner add the profits of their business to their salary to derive their overall servicing income.

In other words the bank is “grouping” your income.

However, you need to take the good with the bad.

The bank is opening up your company’s giving you a “servicing boost” by letting you use your business’s income for your personal borrowing capacity. In doing so, any loans in your business also have to flow into your personal borrowing assessment.

Let’s take a look at an example.

Example 1

Say your business generates Net Profit Before Tax of $200K. And from your business, you paid yourself a Director’s salary of $100K. Assume you have no other personal loans today, and the bank is letting you borrow 6 times your income.

Your total borrowing capacity is therefore $1.8M.

However, because you are using the $200K profit in your business to achieve the $1.8M, the bank will also start factoring your business loans into your assessment.

This means any business loans will start taking away from your personal borrowing capacity.

For example, $500,000 in business lending may leave you with residual borrowing capacity of $1.5M.

However, what actually happens is because many business loans are shorter term in nature, $500,000 in business lending may equate to much more in home lending, thereby reducing what you can borrow in your personal life.

Approach 1 – Group Assessment Example

Basically, under a Group Assessment, you can’t have your cake and eat it too. So what’s the solution to this?

Approach 2: A Standalone Assessment

A standalone assessment may help you manage the impact of business lending in your personal borrowing capacity.

This type of assessment typically applies to larger, more mature businesses, with multiple shareholders and directors.

It may also require some forward planning relating to the income you draw from your business, whether in salary or in dividends, and going to a bank who can look at your income in this way.

In a Standalone Assessment, this is when a bank DOES draw a line between you and your business. However, these conditions apply:

  1. You are drawing sufficient income within a Financial Year to support your desired borrowing capacity
  2. Your business is profitable, and there is sufficient cash flow witin your business to support your ongoing commitments

Even though you business’s income is not being used for servicing, most banks will still want you to prove the status of your business. This can be done by:

  • showing your financial statements, or
  • at least providing an accountant’s letter advising that the business is profitable.

Example 2

Going back to our example.

Assume now you’ve instead decreased your Business’s Profits to $100,000 and increased your salary to $200,000.

Based on a 6x Debt Capacity, the bank may lend you up to $1.2M on this salary.

Approach 2 – Standalone Assessment Example

If this loan amount is sufficient to meet your personal borrowing goals AND the $100,000 profit left in the company is enough to service your business debts, then the bank is more willing to draw a line between you and the company, and exclude your business loans from your assessment.

When this happens, your personal borrowing is not impacted by your business loans, and the derived borrowing capacity is yours to keep.

This approach may also be helpful if the lending within the business is very complex, or if there are other shareholders, unwilling to share the financials of the company to third parties.

So we have now looked at the two ways that a bank assesses your business loans and how they may impact your home loan borrowing. A related topic which we have covered in a previous blog post is “Can I Get a Loan if I Don’t Draw a Salary from the Business?”.

Speak to a broker

Thank you for reading and please stay tuned for more finance tips for business owners.

If you have questions or comments on this topic, you are more than welcome to get in touch with Tommy Lim () or the SF Capital broking team.