While your tax affairs are a lot more complex than those of a salaried employee, as a director and shareholder, your Limited company provides flexibility in how you extract value from the business. One area that can significantly impact your ability to secure a mortgage is an overdrawn Director’s Loan Account (DLA). Not only do lenders scrutinise your financial position in great detail, where an overdrawn DLA can raise red flags that may affect your mortgage application, but in most cases, an overdrawn director loan account is often a result of insufficient profits to declare the dividends you have paid yourself.
What is an Overdrawn Director’s Loan Account?
The best way to think about a Director’s Loan Account is a chitty that records all the transactions between you and the company, which are not salary, allowable dividends or reimbursement of expenses. If you pay yourself more money than you put on, then your DLA becomes overdrawn, and you must repay it within the required time frame. In effect, you are borrowing money from the company.
What are disallowed dividends?
Dividends are a distribution of profit. It is a way of providing shareholders with a return on their investment. As an SME limited company, typically, directors and shareholders are the same people, and dividends are a tax-efficient way of paying yourself out of the business. However, your company must make enough profits after tax to cover these amounts. If it does not, then the dividend is disallowed and added to the director’s loan account. In effect, you owe that money back to the business.
Let’s use Fred as an example. He runs his own limited company and pays himself dividends of £2,000 a month. In 2023, he made £30,000 and paid £6,000 in corporation tax, which left £24,000 in profits after tax, which covered his monthly dividends.
In 2024, Fred continued to pay his dividends of £2,000 but unfortunately had a huge repair bill on his van. As a result, his profits were reduced to £25,000, and he paid £5,000 in corporation tax, which left £20,000 of earnings after tax. As he took all the profits after tax last year, there was only £20,000 of profits to pay a dividend on this year; £ 4,000 of the £24,000 Fred has paid in dividends need to be paid back, to account for this. This is posted to a director’s loan account.
How Lenders View an Overdrawn DLA
Mortgage lenders assess affordability and financial stability when reviewing applications. An overdrawn DLA can impact this assessment in several ways:
- Reduced Income Consideration – There are two impacts here, firstly using the example above Fred’s income will of reduced for 2024 which will reduce the amount that he could potentially borrow. Also if you have taken substantial director’s loans instead of salary or dividends, lenders may question the sustainability of your income.
- Increased Financial Risk – An overdrawn DLA can indicate that you are not in control of your numbers and could have potential cash flow issues within your business. Lenders may see this as a sign that your company is struggling, making them less likely to approve your mortgage.
- Tax Liabilities – If an overdrawn DLA is not repaid within nine months of the company’s year-end, the company may have to pay an additional 33.75% tax charge under Section 455 of the Corporation Tax Act 2010. This could impact the company’s cash flow and affect your overall financial position.
- Potential Legal Implications – In extreme cases, if your company becomes insolvent, an overdrawn DLA may be seen as a debt owed by you personally, which could lead to legal and financial complications. Lenders will factor in this risk when assessing your application.
- Reduced Income Consideration – There are two impacts here, firstly using the example above Fred’s income will of reduced for 2024 which will reduce the amount that he could potentially borrow. Also if you have taken substantial director’s loans instead of salary or dividends, lenders may question the sustainability of your income.
How to Minimise the Impact on Your Mortgage Application
If you have an overdrawn DLA and are planning to apply for a mortgage, consider the following steps:
- Repay the Loan – Where possible, repay any outstanding director’s loans before applying for a mortgage to show financial stability.
- Seek Specialist Lenders – Some mortgage lenders are more experienced in dealing with company directors and may take a more flexible approach.
- Work with your mortgage advisor – in Fred’s situation the reduced income may not be able to provide a mortgage to cover his borrowing requirements. Working with a mortgage advisor can help understand your earnings requirement to be able to meet your borrowing requirements.
- Consult an Accountant – Once you understand your earnings requirement an accountant will be able to work with you to recommend strategies so that you can increase your earnings. This may delay your application but will prevent any nasty surprises.
Final Thoughts
Consideration needs to be given to an overdrawn Director’s Loan Account and the impact that it can have on a potential mortgage application; it can create obstacles when applying for a mortgage, as lenders may see it as a sign of financial instability and, in most cases a declining income. If you are a company director planning to buy a home, managing your finances and profitability is essential to maximise your mortgage prospects. Planning ahead, repaying outstanding loans, and working with your mortgage advisor and accountant can help improve your chances of securing the mortgage you need.
At Spotlight Accounting we have worked with a number of clients using our Spotlight on Track and Spotlight on You, to produce a forecast on how to get out of an overdrawn directors loan account position and working with clients with interim accounts to keep on track to clearing the loan.
