To understand contractor mortgages, you first have to understand contracting. That may, and should, sound obvious.
But it would surprise you how few mainstream lenders ‘get’ contractor payment structures. Limited company and umbrella contractors face a constant battle proving what they can afford. Or it definitely seems that ignorance at branch and call centre level is rife.
The good news is that, if you’re a contractor looking for a mortgage, we can help.
We don’t need payslips or accounts to prove how much you can afford to borrow. I’m sure a High Street mortgage lender has asked you for such if you’ve been there already.
No. Our mortgage borrowing terms reflect your greatest asset: your contract rate.
If you’ve approached a mortgage adviser and they’ve asked you for accounts, walk away. Going down that route, the self-employed route, could do you more harm than good. Here’s why…
The fact is, there are lenders who accommodate limited company contractors. But if a bank has such policies in place, they tend not to make them available on the High Street.
Why not? Here are two valid reasons in-branch advisers don’t deal with contractors direct; they:
Here’s the underlying issue that contractors face. Lenders tailor the majority of their ‘off the shelf’ mortgages to PAYE employees. Full- or part-time workers fit their affordability calculation a treat.
That’s not so with independent professionals, whose typical contract is far from permanent. Often, clients engage contractors for three or six months at a time at the most.
And that there’s the issue. It’s the nature of these short-term contracts that derail contractors’ applications for mortgage funding.
That’s why we need contractor-friendly lenders, who appoint specialist underwriters to accommodate contractors’ applications.
But here’s the thing. You won’t find these underwriters in your local branch on a Saturday morning.
They work from head office, not in-branch. And they either deal with an appointed mortgage broker or their own staff, not the public.
Is this outlook because the bank or building society has a grudge against contractors? I don’t think so.
Before you’re quick to judge, consider this. Since the credit crunch, every mortgage lender is under constant scrutiny. If it’s not by financial ombudsmen, the public is keeping its eye on them, too.
The Mortgage Market Review and Responsible Lending Guidelines have all helped determine lenders’ strategies. That’s why they dot all the i’s and cross the t’s, especially with larger loans like mortgages.
For some, three- or six-month contracts don’t offer the security their mortgage criteria demands. Thus, you’ll only find the underwriting process that contractors need through specialist brokers.
In the vast majority of branches, advisers can only offer standard underwriting criteria. This method doesn’t accommodate independent professionals working on continual short-term assignments.
So if you say you’re a contractor, the advisor will pigeon-hole you without thinking. In their eyes, you’re self-employed; that’s how conditioned they are to their employer’s products. It’s also why you should choose an independent broker with access to all the market.
It may be that the adviser’s bank offers a bespoke range of mortgages for contractors. Even then, typical High Street branch staff may not be aware of those products. They’ll process your information with a view to offering you a self-employed mortgage.
In a way, they’re right; you are self-employed. But your limited company accounts are anything but straightforward. If your accountant is doing their job, you claim all manner of tax relief.
The effect of this relief on your retainable income is superb. By paying yourself a small salary and dividends, you keep your NICs and income tax to a minimum.
But there is a sacrifice, a pay-off if you like, for your tax efficiency. What your streamlined accounts won’t support is an application for finance, especially a mortgage.
So, today, I want to outline these definitions:
Our definition, in 50 words or less:
"Contractors can access the same mortgage deals as everyone else. The big difference lies in how lenders underwrite contractor mortgage loans.
Affordability calculations lenders use to assess contractors' relevant earnings don't use accounts or payslips. They base how much a contractor can afford to borrow on their contract rate alone."
In many ways, you not filling out their application is a good thing. The obvious point is: it’s a waste of time! You don’t fit High Street lenders’ applicant’s profile.
But there’s a more sinister outcome of applying for mortgage funding with generic lenders. Let’s explain.
This is how a typical contractor’s mortgage application would work in branch.
The in-branch IFA will take your details, including a copy of your contract. Now, most limited company contractors earn a good deal more than their full-time peers. So, upon noting your day rate, the advisor’s eyes light up. On the face of it, that’s a great start.
Then they look at the term of your contract. Here’s where the High Street method begins to struggle with the way contractors work.
Even if your engagement is for twelve months, it will raise alarm bells. The IFA would no doubt ask questions about contingency plans. What happens to your income when the current contract ends?
You’d tell them, “That’s it!”, as far as obligation goes. But, you add, you’re doing a good job for your client, agency or umbrella company. It’s safe to assume that they’ll offer you a renewal when this contract ends.
Now, this advisor has to follow Responsible Lending guidelines. Or at least their bank or building society’s interpretation of them.
With no guarantee of income continuity, your contract may not offer them enough security. It will depend upon their interpretation of FCA recommendations following the Mortgage Market Review.
But, rest assured, their smile’s no longer as broad as it was when they saw the value of your contract.
The next move for the adviser is to verify your income using your accounts and bank statements. Now, remember: they’ve seen your day rate on your contract. They’ve worked out your extended annual income based on that figure.
With the concern over your status, that high income is maybe the only reason you’re still in the room. But now you’re throwing them another curve-ball.
They cannot understand your ‘take home’, your low salary and drawn dividends. Why do they look so low in comparison to your day rate?
It’s at this point where being a contractor can be a curse rather than a blessing.
We know that your accountant ensures you claim all the tax relief to which you’re entitled. Part of that process involves you drawing low salary and dividends.
But what about the rest of your income? You retain it as profits within your business.
I know it, you know it and your accountant orchestrates it. But an in-branch mortgage adviser working to an employee-biased affordability calculation? They won’t know that!
They’ll take one look at your salary and dividends and use that sum to work out how much you can afford to borrow. Even if they do make you an offer based on that figure, it won’t be for the mortgage you know your earnings deserve.
Then, if you’re really unlucky, they’ll go through the motions for you. They’ll send your mortgage application to the underwriters at head office. And that’s where things begin to turn sour in earnest.
Given what they now ‘know’ about you, your IFA will almost certainly stamp your file “High Risk”. They’ll then send it off to the underwriters at head office via internal mail.
This stamp alone puts the underwriter on alert, but they do the credit search anyway. That’s fatal, given the scenario!
You’ve maybe guessed that the lender doesn’t think you can afford the mortgage you want. That was probably clear at the meeting.
So when they reject your application, you’re not surprised. But no harm done, right?
That they’ve not taken into account your retained profit matters little, now. You’re done with them, and vice versa.
What happens when you go to another prospective lender? Maybe one a similar contractor tells you they’ve used?
All a credit agency has seen is the amount the previous lender’s stated you earn and what you wanted to borrow. That, plus any other history they have on record for you, of course. Altogether, you get a big, fat fail.
That rejection, innocuous at the time, remains on your credit report for up to two years.
That’s bad enough in itself, but that black mark also has a knock on effect. It may deter other lenders with contractor-friendly policies who could have helped you.
They see that recent failed credit search and they too begin to wonder.
If it’s a mainstream lender you approached, it could be even worse. Your new lender may just assume that if one of the big boys couldn’t get you a mortgage, how are they supposed to?
That begins a downward spiral, leaving your credit file scarred for the foreseeable future. Unless, of course, you approach a specialist broker before too much harm’s done.
Here’s the advantage contractors get applying for a mortgage through a specialist broker. They, the broker, already understand your payment structure.
But it gets better. They can package your mortgage application so that specialist underwriters can see it, too. This combination elevates your potential borrowing above your High Street expectations.
To work out your potential borrowing, they’ll ask you for just a few documents. Not accounts. Nor, with the exception of Umbrella Company Contractors, payslips.
On this basis, your past income has no bearing on your potential future earnings as a contractor.
This is what you need to provide for a broker to process your contractor mortgage application:
Since the pandemic, lenders might ask for your SA302, too. More often than not, this is to check you’re paying taxes as you should. Contractor-friendly lenders don’t, as a rule, use SA302s to work out affordability. And that’s it: all the documentation you need to apply for a contractor mortgage.
This process is called contract-based underwriting, and is especially helpful for those new to the lifestyle. Not everyone has had time to accrue a portfolio of clients, awards or accounts.
So in theory, a contractor with perfect credit can get a mortgage on the first day of his first contract. That’s if:
Tick all those boxes and you’re off to a good start. Newbies and long-standing contractors alike can qualify for the same contractor mortgage underwriting process.
Once past the gatekeepers and with a broker who knows what you’re about, you’re on a level playing field. You’ll find the mortgages you can access no different to those that you could when you were an employee.
In fact, the application process itself should take less time. That’s because there are so few documents to clog the pipeline. But there are still warning signs you should look out for.
Most lenders will try to entice you with a same-day agreement in principle. It’s tempting because it may be closer to buying a home than you’ve got anywhere else to date.
Before signing up for an AIP, make sure that the broker understands ‘contract-based underwriting’. They may be trying to sell you a self-employed mortgage based on your accounts. These are not the same as bona fide contractor mortgages and can lead you down a rocky road.
Once you get an AIP, a real one issued by the lender, the contractor mortgage process is seamless.
That there are so few documents to process plays a big part in their simplicity. The entire timeframe should take no longer than 3–6 weeks to get an official mortgage offer. That’s application to completion in a month and a half, and often a lot less.
Yes, it can take a little longer if the lender your broker approaches is running a promotion. Or if, like recently, we’ve hit the end of a Stamp Duty holiday or come out of lockdown. But the delay for you will be a lot less than for permies going through the same lender.
With regards to the type of mortgage, there are no limitations for contractors. Fixed, variable and tracker rates are all available.
You may even drop lucky. Your broker should have a direct line to contractor-friendly lenders’ underwriters. On that basis, they may have exclusive mortgage offers that you won’t find on the High Street. Not anywhere, with anyone, regardless of tax status.
It takes a long time to build that depth of broker-underwriter trust. But there’s a handful of true specialists who’ve worked with lenders over many years.
The resultant relationship has opened up a whole new market to mortgage providers. As such, all parties — brokers, underwriters and applicants — benefit as a result.
You may also have heard that deposits for contractors are much higher. That’s not true at all, but there is an explanation for why it’s a common misconception.
The 2007 economic crisis was, in some ways, a blessing in disguise. It brought about the now infamous credit crunch; again, a necessary evil.
Before it, lenders’ go-to self-employed product was the now defunct self-cert mortgage. It was a guaranteed route to getting a mortgage as a contractor; but, you paid the price.
Interest rates for self-cert mortgages were high. That’s because, for one, the lender recognised the inherent risk alongside self-certification. For two, the market could support higher interest rates.
And this is why contractors should tip their hats to the credit crunch. Interest rates for self-cert were way higher than those available today for contractor mortgages. The only way to reduce interest rates then was to find a bigger deposit, thus lowering the lender’s risk.
Was it this scenario that fuels the myth that contractors need bigger deposits today? Perhaps, but not on its own.
Don’t get me wrong: that risk element is still true today. The more you put down, the lower you’ll find the interest rate on the balance of your mortgage.
But you have to think of the mindset back then. In the mid-noughties, almost all lenders offered 100% mortgages. The thought of utilising bigger deposits has a different connotation today.
The Mortgage Market Review played a part, too. And because of its subsequent guidelines, lenders pulled self-cert off their shelves.
But they weren’t the only casualty. Interest only mortgages also took a hit.
Interest-only was another type of lending that contractors favoured. The reason? With their profits, they could pay off swathes of the mortgage balance at contract or year end. This meant they continued to whittle away at what they owed, paying less and less interest every year.
But after the Mortgage Market Review (Responsible Lending), all that changed. Without a 40% and 50% deposit and a sound investment vehicle, that was it. You could forget it. They became the smallest bargaining chips lenders would accept for interest-only mortgages.
It took the best part of a decade for lenders to find favour in this type of lending again. And, thankfully, you’ll find many interest-only deals for contractors offered by a plethora of lenders today.
Both of these situations give lie to the myth that contractors need a greater deposit. Today, many lenders have become enlightened. Deposits for contractors are no higher than for permies.
But these Eureka moments have only happened because of the work of specialised brokers. Despite more lenders offering mortgages for contractors than ever, that route hasn’t changed. And if the wheel’s not broken, why fix it?
So, the lower the loan-to-value ratio, the lower the incumbent interest rate. In English: the more you put down, the better chance you have of reducing your mortgage interest rate.
That’s true across the spectrum of the mortgage market. The less you owe, the more secure the loan is for lenders should you fall on hard times.
But even contractors with small deposits can qualify for the government’s Help-to-Buy initiative. As long as their credit file is squeaky clean, they can apply for a H2B mortgage with only 5% deposit.
So, do contractors need bigger deposits than ‘permies’? 100%, no!
And that about wraps this guide up.
Mortgages for contractors are, in essence, no different. High Street lenders may tell you that they are contractor-friendly, but be en garde. In truth, most only offer self-employed mortgages. They’re not the same.
If an advisor looks confused when you mention “Contract-based underwriting”? Thank them for their time, but high-tail it out of there. You’re setting yourself up for a fall, from which there’s a long climb to get back on the horse.
Go with the smart money and use a specialist contractor mortgage broker. Always!
John Yerou is a pioneer of contractor mortgages and owner and founder of Freelancer Financials, Contractor Mortgages®, C&F Mortgages and Self Employed Mortgages, trading styles and brands of the award-winning Mortgage Quest Ltd.