As anyone who has ever taken on a contract knows, there are pros and cons to the contracting life. After a decade in banking and loan approvals, I’d like to share some of what I’ve learned to help you navigate your professional finances when contracting.
We’ve talked in the past about managing the transition from permanent to contract, how to manage contracting over holiday periods and how to keep your contract for longer.
One of the cons some contractors experience is the ability to demonstrate to banking institutions, on paper, the ability to repay a loan when applying for one. This can be something individuals consider when making the decision to contract over taking a permanent role. And delving down deeper, whether you contract as a PAYG or a Pty Ltd or other company structure.
There has been a number of changes in recent years regarding banks and the way they lend to contractors, but the good news is that it’s not all doom and gloom as nothing has fundamentally changed. It is more important now than ever to be informed and prepared if you are looking to borrow money from your banking institution.
How do the banks assess your borrowing capacity?
In order for banks to understand a Contractors ability to repay a loan, they are now requesting you provide more evidence regarding your ability to make sustained repayments. Ultimately this is a good move because it will also demonstrate to you what you can actually afford.
Put simply the banks need you to show them you can:
- produce an income
- consistently save
- control expenses
Once you’ve demonstrated your finances, they require an outline of what you plan to do with the money you are borrowing (ie buying a property), and what your plans are for the asset you are purchasing (ie living in it or renting it out). These requirements are the same for any borrower.
So how do we prove this, what do they want see, and what are they looking for in these documents?
What sort of documents do the banks actually need?
For all Individual Borrowers
- Copies of up to 6 months’ worth of Bank Statements for all bank accounts, including savings accounts.
These are used to verify your monthly expenditure and will be checked against your declared expenses on your application form, so be honest and if there are items on the statement which you do pay regularly, consider if they are necessary moving forward, this is also used to identify payments to other liabilities.
- Copies of 6 months worth of statements for each and every debt you have. These would include:
- Home Loans statements
- Personal Loans statements
- Credit card statements
- Car loan/ lease statements
- Store card statements
These are used to calculate the required monthly payments and to verify that you are currently meeting your debt obligations.
For “PAYG” Contractors
In addition to the above, PAYG Contractors may also require:
- 2 years personal tax returns and associated Assessment notice.
Can be used to evidence and explain your ability to earn income consistently and will form a foundation for the income assessment.
- 2 most recent consecutive pay slips, payment summaries for any other roles worked in the current tax year as a supporting document to assist with questions.
Provision of the extra information eg Payment summaries will assist your banker in demonstrating your current contract position remuneration and can be used to suggest increased earnings if significantly different to your recent tax returns. Also being prepared like this demonstrates your understanding of your financial position and gives your banker the best chance to get the best borrowing potential.
For PTY LTD or Family Trust Contractors
If you pay yourself through a Pty Ltd or Family Trust arrangement, the list is a little longer and more complex as it will depend on the specific ways in which you have structured your business and manage your expenses/deductions. It is important to keep in mind how you distribute your earnings, as sometimes the most tax effective approach does not translate to the best borrowing potential.
No doubt most of you operating the above already have a professional team of planners and/or accountants who can assist you with advice. We highly recommend getting a good team you trust and working with them towards your goals.
The good news is that it’s not impossible to secure a loan with your banking institution however you do need to be prepared with your financials easily accessible (and in order!) to be able to do so. We recommend you making a time to meet with your banking institution to discuss your options to get a clear picture on your own specific situation.
We have conducted some early discussions with a Big Four bank around hosting a Q&A session in our Melbourne office, where a number of experienced bankers and financial planners could provide information around borrowing and superannuation. If this is of interest to you please get in touch so we can add you to the mailing list.