The self-employed surge

Small businesses are often called the engine room of the economy, with 98 per cent of all Australian businesses being small (having less than $10 million in turnover). But if you dig down deeper into the stats, a large proportion of small businesses are actually self-employed.

According to the Australian Bureau of Statistics (ABS), over half (61 per cent) of Australian businesses are self-employed/non-employing. It’s believed that self-employment currently empowers 1.6 million Australians to secure a steady income while maintaining independence and the ability to work flexibly.

As such, self-employed businesses are particularly concentrated among older individuals and women, with more than one in five self-employed people being aged 60.

Add on top of that an additional 27 per cent of businesses employ one to four people and 9 per cent employ five to 19 people. There’s a huge number of people needing specialist finance to help their businesses grow and secure a mortgage for the home of their dreams.

While self-employed borrowers have almost always needed the support of specialist lenders to access finance (given their typically lumpy cash flow), the tightened serviceability environment has seen an additional surge in self-employed borrowers turning to non-bank lenders such as Pepper Money, Resimac, and RedZed.

According to Steve Wallace, regional sales manager at Resimac, part of the growth comes down to the fact that non-banks have more appetite for self-employed customers than the banks, as they can verify income through alternative documentation (alt doc) methods while remaining compliant and competitive, thereby simplifying the process for the customer and sometimes resulting in increased borrowing power.

Wallace noted a strong self-employed borrower trend in recent months in particular. In fact, since 1 July 2023, self-employed borrowers have accounted for approximately half of the lender’s settlements.

“With significant changes to the economy over the last few years, we’ve only seen the self-employed market grow,” he said.

Moreover, the banks’ regulatory requirement to service loans with a 3 per cent buffer may also be pushing more borrowers to non-banks, which are not beholden to the same laws.

Adrian Fisher, head of distribution and product at RedZed, revealed that self-employed Australians often approach RedZed after having “a disappointing experience with a mainstream lender”.

“Many of our customers have had loan amounts reduced or loan applications declined by traditional banking institutions due to restrictive assessment criteria, or they have simply walked away due to unrealistic approval conditions,” Fisher said.

“For example, some mainstream lenders apply hefty servicing buffers, restrictions on add-backs or require self-employed borrowers to produce two years’ worth of business financials. This simply isn’t feasible for many small-business owners, which is why these borrowers turn to lenders like us, who understand the realities of being self-employed and running small businesses.”

Pepper Money, which sees around 40 per cent of its flow come from self-employed borrowers, told The Adviser that servicing buffers were playing a role in strong demand.

The lender’s general manager mortgages and commercial Barry Saoud commented: “Rising interest rates, high inflation, supply chain issues and labour shortages mean sole traders, small-business owners and independent contractors may be doing it tough… “Pepper Money’s servicing buffer of 2 per cent applies across all loan products, purposes, and LVRs, providing borrowers with greater flexibility.

“We can also provide further servicing discretion for investor purchases, refinance and debt consolidation, and fixed-rate loans (for applications meeting specific eligibility criteria).

“A ‘no’ from a bank could be a ‘yes’ from a non-bank lender like Pepper Money.”

What are self-employed borrowers needing finance for?

While self-employed loans are always needed, there has been a recent uptick in lending requests from self-employed borrowers looking to clear ATO tax debts, after the Tax Office announced its intention to crack down on the 40,000 businesses that have collectable debt.

RedZed’s head of distribution and product explained: “At the start of FY24, the Australian Tax Office (ATO) began issuing warnings to business owners to pay their tax debts and engage with their super obligations, or risk having their debts disclosed to credit reporting agencies.

“The ATO was eager to re-establish the culture of paying tax on time, and to recover the billions of dollars owed in small-business taxes that accumulated during the COVID-19 pandemic.

“Debt disclosure can adversely impact borrowing capacity, supplier retention and the ability to open trade accounts, so it wasn’t surprising that we saw an influx of business owners seeking tax debt funding solutions in order to meet the requirements of the ATO and avoid debt disclosure.”

Resimac’s regional sales manager agreed, stating: “We are able to clear out ATO tax debts, which can be a significant burden lifted off the shoulders of business owners.”

Similarly, Pepper Money’s Saoud told The Adviser that there was a “massive opportunity to help those who are mainly self-employed and their families get into homes, and consolidate any tax or general debt”.

He said they could access “better deals” by going to lenders that allow alternative documentation/verification options, such as tax returns, financial statements executed by an accountant or tax agent (one or two years), an accountant letter, six months’ BAS, or six months’ business bank statements.

Other common themes emerging from the self-employed lending landscape include the fact that the cash rate environment has stabilised (with many commentators suggesting we’re now at the peak of the tightening cycle), which has resulted in renewed confidence to invest in business growth opportunities. Add to this a rising popularity in SMSF lending from self-employed borrowers (as they move to invest in property without significantly impacting their take-home income) and a growing volume of businesses looking to repurpose their commercial property post-COVID-19 and volumes are only expected to continue to rise.

Top tips for writing self-employed loans for the first time

As with any new process, brokers are always encouraged to take up the broad range of educational materials, courses, and support offered by their lender partners.

On a day-to-day basis, brokers can also lean on their non-bank business development managers (BDMs) and relationship managers (RMs). These BDMs and RMs will typically have access to a broader product offering to workshop the potential deal – not just for the client’s immediate needs but for requirements they are likely to have going forward.

“Working with a BDM/RM that understands how to review a self-employed applicant’s financials is important, as this can differ from a PAYG applicant,” Wallace said.

Brokers may also want to consider whether the lender is capable of assessing an application in its entirety, as opposed to solely relying on current financials.

Fisher explained: “Self-employed customers require an ‘all hands on deck’ approach to ensure the desired outcome is achieved. Also bear in mind that working with self-employed clients has many benefits, including the fact that they generally have ongoing and diverse lending requirements, which often results in repeat business opportunities.”

Pepper’s general manager, mortgages and commercial added that there are several cross-selling opportunities for brokers when it comes to self-employed clients, particularly for leasing, insurance, and asset finance products.

“They are much ‘stickier’ clients with more regular finance needs,” Saoud said, as their business needs regularly change.

He concluded: “Brokers understand the unique income structures of self-employed individuals and have an opportunity to reassure these self-employed home buyers that there are still options for them.”