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While being self-employed offers some great benefits, possibly one of the biggest drawbacks is how difficult it can be to obtain a home loan. When applying for a home loan, you will generally need 1-2 payslips to verify your income and your capacity to repay the loan. For a PAYG employee this will generally be sufficient to substantiate your base salary. In contrast, if you are a self-employed applicant then you will be required to have 2 years’ worth of lodged tax returns to demonstrate your income with most lenders.
Many self-employed applicants don’t have up-to-date financials, and this is where a low doc loan can bridge the gap to obtaining finance.
What is a Low Doc Loan?
A low doc loan is typically available to self-employed borrowers or borrowers with limited documentation. As the name suggests, these loans have lower documentation and income verification requirements than traditional loans.
Why use a low doc loan?
The obvious reason to use a low doc loan is because income verification is difficult. Some examples include:
- Tax returns that aren’t up to date
- Recent business/income growth that isn’t reflected in past returns
- Complicated business structures
- Trust distributions from the business (particularly to adult children for tax purposes)
- Large non-cash expenses such as depreciation
What are the benefits of a low doc loan
The major benefit of these types of loans is they can be a benefit for borrowers who may not have access to traditional forms of documentation, such as up-to-date tax returns. The most common acceptable methods of income verification include:
- Business Activity Statements (BAS)
- Accountant’s declaration
- Business banking statements
Consequently, low doc loans can also be faster and easier to obtain than traditional loans. The assessment of your application by the credit assessor is less complex that a traditional self-employed application because they don’t need to see your financials and tax returns. This can assist borrowers who need to obtain financing quickly.
What are the drawbacks of a low doc loan
Overall, while low doc loans can be helpful for borrowers who cannot provide traditional documentation, but they do come with some drawbacks since lenders perceive them to be higher risk.
Higher interest rates
Low doc loans typically have higher interest rates than traditional loans. This can also vary between lenders depending on how flexible they are with income requirements. Some lenders have a more generous approach than others and this will be reflected in the rate offered.
Lenders look at the size of the loan vs the value of your property. It is common practice that once the loan-to-value ratio (LVR) exceeds 60%, a tiered interest rate schedule usually applies with most lenders. So, the more you want to borrow as a percentage of the value of the property, the higher your rate will be. Consequently, you will need to have a large deposit if purchasing or considerable equity if looking to refinance to keep your rate down.
Despite the above, it is possible to get a low doc loan with a 90% LVR loan at the time of writing. It does come at a higher rate of course.
Lenders Mortgage insurance (LMI) or Lenders Risk Fees
LMI can kick in at lower LVRs. That is, even if you have a decent sized deposit, you still may be required to pay LMI. However, it is more common for there not to be LMI because mortgage insurers don’t like to operate in this space. In this case the lender will likely charge their own ‘Risk Fee’ for the extra risk they are taking.
This follows on from the last point. The lender may charge an application fee due to the higher perceived risk. At lower LVRs there may be no fee but as the LVR creeps up a lender can sometimes charge more than 1% as an application fee.
What will a lender look for when assessing your application?
There are several aspects a lender will be looking at when assessing your application. These include:
Length of trading.
The sweetest spot is an ABN registered for 2 years and GST-registered (if applicable). There are solutions for people with an ABN registered between 6-12 months. Finally, there are lenders that will take from 1 day with an accountant prepared business plan but the rate will be high.
The lower your credit rating, the more likely you are to be charged a higher interest rate. There are lenders that will look at imperfect credit files or ignore them completely.
This is calculated by dividing the loan amount by the value of the property. As a rule, the lower your valuation and the smaller your percentage of ownership, the less likely you’ll get funding.
While lenders may be willing to take a risk on you, they want the loan to be secured by a quality, standard property. Properties that are unique in nature, in very regional areas or in need of major repairs are not readily accepted.
The value of your assets.
Lenders will generally want to see a reasonable level of assets given your age
What documents do I need to apply for a low doc loan?
In most cases, you will need to provide the following:
Low doc loans are a great alternative solution for self-employed applicants without full financials to verify their income. This may be for any number of reasons.
There are advantages and disadvantages to going down the low doc route but ultimately it depends on what you are trying to achieve and what verification you have at hand.