Mortgage challenges for contractors: responsible lending

There are many myths about the inaccessibility of contractor mortgages.

It's easy to see why. Many high earners with impeccable credit history can struggle to find willing lenders.

This spurious 'knowledge' makes it natural to assume that a poor credit score is an immediate barrier to entry.

That's not always the case.

Our team of brokers works with many specialist lenders. We have to in order to 'interpret' contract income for underwriters.

There are even some, like Kensington Specialist, who'll work with contractors who have less-than-perfect credit.

Here's how it works (and why it might not for you!)…

Here at Freelancer Financials, we're renowned for providing mortgages from contractor-friendly mortgage lenders. Drawing upon relationships with lenders for whom adverse credit is less of an issue is part and parcel of that service.

The self-employed populace of the UK is growing exponentially. Therefore, lenders reaching out to contractors with poor credit had to happen.

It may not be obvious, but several well-known High Street banks and building societies have also recognised this growth.

They've realised that ignoring contractors makes them inaccessible to a growing market.

Advisers at High Street branches won't deal with contractor mortgages and bad credit ratings. Senior underwriters, with whom we deal directly, will. Moreover, we know what they want from your application, and how to present it.

It's not you, honey, it's me. Honestly.

We're not saying that all banks and building societies won't deal with contractor mortgage applications. Some do, and do a decent job of it. What we are saying is that we can save you the hassle, time and money of finding you the right one because we deal with them every single day.

More importantly, we know how best to present your credentials to give your application the best chance of success. Yes, even if your credit history exhibits the odd misdemeanour.

On the High Street, your problem will be that you don't fit the pigeonholes that lenders reserve for low-risk applicants. You pay yourself a low salary on purpose: to remain tax-efficient. Most in-branch and call centre advisors don't grasp this concept!

We've heard so many tales of woe from clients who've come to us desperate for help. You may be familiar with this scenario.

You, the contractor, arrive at the branch to discuss a mortgage, 3 years' accounts prepared as requested. Yet even with so much documentation, the advisor fails to see how easily you could afford that mortgage.

You leave despondent, frustrated and no closer to owning a home. So where did it all go wrong?

How can contractors prove their affordability to a mortgage lender?

Many lenders have shown extreme sensitivity when interpreting FSA responsible lending guidelines. The guidelines form part of the Mortgage Market Review, which followed the global financial collapse.

So, by refusing you a mortgage because of your low salary, they're only doing their job. Not that that's any consolation to you.

We're not saying that the contractor-friendly lenders with whom we deal are ignoring those guidelines. Far from it. We've sat down with them to explain:

• why a contractor's accounts show low salary and dividends;
• how you cannot calculate a contractor's mortgage affordability using their take-home pay;
• why a 6-month contract is no different from a head-hunted employee who moves from post to post;
• why contractors retain more of their income, they're lower risk than their 'permie' peers.

It would be wrong to suggest that all banks and building societies welcomed our proposals with open arms. Of course, some didn't; otherwise, why the need for specialist mortgage brokers like us?

But what we do have is a clear perspective of lenders willing to work with us, thus you. The result is a swift and efficient process for documenting your mortgage application.

How much can I borrow?

We now have an approved calculation for contractor mortgage affordability.

You'll be glad to hear, it doesn't involve you having to present 2- or 3-years' worth of accounts.

Why? Because specialist underwriters don't need them.

Instead, the calculation uses your base contract rate, annualised over 48 weeks.

We do this because your contract is a true reflection of your future earnings capacity, thus affordability. This document offers clearer guidance than advisors can glean from past accounts.

To work out how much you can borrow, you first need to work out your annualised rate. Do that by:

• taking your day rate (or hourly rate x 8),
• multiply it by 5 (assuming you work 5 days per week) and, finally,
• multiply the total by 48 (weeks you work per year).

You now have your annualised contract rate. If you were an employee, this would be the equivalent of your 'salary'. Next, you need the lender's multiplier to give you your contractor mortgage affordability.

The average multiplier is 4.5 times your annualised rate So, multiply that by 4.5 to give you an idea of the amount you could borrow to buy a home.

nb: some lenders use a multiplier as high as 5 times your annualised contract value. To err on the side of caution, we base your affordability on 4.5 times your salary. This way, your threshold may even increase when you decide to take action and get a specific quote based on your circumstances.

Instead of doing the calculation yourself, use our contractor mortgage calculator. It uses the equation above to work out the ballpark figure that you could borrow today based on your annualised contract.

How does your contractor mortgage calculator work?

Our mortgage calculator uses average figures that the lenders with whom we deal offer us. But please remember that every client is unique, as are their circumstances.

To gauge a precise figure, it's worth taking five minutes to talk to one of our experts. They're specialists in helping all types of self-employed people find the right mortgage for them.

And don't be shy! Little about the way you work will surprise them. You can talk to our staff - in 100% confidence - at a time to suit you to get the ball rolling.

Before you do, there are one or two instances we need to point out. These may affect the best contractor mortgage interest rates that our staff can secure for you.

The bigger the deposit you have, the better

As with applicants from any walk of life, the bigger the deposit you put down, the lower your mortgage interest rate will be. The more competitive rates begin when you have a 15% deposit.

Still, it may be possible to unlock mortgages with an accompanying deposit as low as 5%.

The longer you fix your introductory term, the higher the interest rate you'll attract. A 2-year fixed rate, for instance, will offer a better interest rate than a 5-year fixed.

The difference is slight, but common practice amongst the vast majority of lenders. They incorporate this safeguard in case the Bank of England increases the base lending rate.

The impact of poorer credit

Whether you're looking for standard or contractor mortgages, poor credit scores may affect your LTV ratio. LTV is the amount a lender will offer based on the size of your deposit.

For instance, someone with good credit may only be required to find a 10% deposit. This gives a 90% LTV ratio. If you have poorer credit, a lender may insist upon a 20% deposit, i.e. offer an 80% LTV.

Your credit score will often have a bearing on your introductory term interest rate, too.

Again, this is commonplace across the "whole of market", not only for contractors. Our recent article introducing Kensington Mortgages explains this topic in detail.

Kensington Mortgages is one of the few contractor-friendly lenders to date. They have "shaken the market" by offering self-employed people with poor credit a step up onto the mortgage ladder. As such, we expect to hear a great deal more of them as the number of UK contractors grows.

What if I'm new to contracting?

What won't affect your application is if you've only been contracting a short time. In theory, you can get contractor mortgages from day one of your first contract.

There is, however, certain supporting documentation you'll need if that's the case. If you've been working as a contractor for less than two years, underwriters will need:

• your CV, to confirm that your chosen contracting niche reflects your most recent work history;
• 3-months bank statements;
• a copy of your signed contract;
• proof of ID;
• some lenders will check your tax status with an SA302, but won't use your 'declared' income to work out your mortgage affordability.

If these are in order, you're potentially in a stronger position than if you'd only recently started work as a 'permie'. Now, admit it: that has surprised you!

If you have other burning questions, call us straight away. Or, browse our archives and our guides for your later reference. These will help you clarify further how a mortgage specialist can help you.

For more in-depth information, please read our comprehensive contractor mortgage FAQ.