For and against: how AIPs can go wrong for contractors
It's important to understand that an Agreement in Principle (AIP) is not a firm mortgage offer. Yet there are advantages to getting one before you begin the application process.
An AIP is a certificate from a lender stating that, in theory, you can afford to repay the mortgage you've asked for.
You won't need supporting documents, such as payslips or bank statements, at this stage.
But the search will leave either a 'soft' or a 'hard' footprint on your credit file. You're within your rights to ask which type when you ask the lender for yours.
Independent contractors should always take advice before requesting their AIP.
That's because few in-branch mortgage advisors understand limited company payment structures. This ignorance could lead to a rejected application and affect your credit status.
The advantages of an Agreement in Principle
All homebuyers should ask for an AIP (or "Decision in Principle"). They're almost always free and can strengthen a homebuyer's position.
They prove to both the vendor and estate agent that you're a serious buyer. If you have an AIP and your competition hasn't, the vendor could favour you over them.
But it's paramount contractors get their AIP from an advisor who understands contracting!
Yes, you can just walk into a branch and request one. It will be good for 30-90 days, depending on their policy. And it will assure estate agents and vendors…
…but the problems start for contractors when they take their mortgage application further.
Why AIPs can give contractors a false sense of security
We have dozens of tales of High Street rejection woe on file from contractors. They get their AIP based on top line income over the counter or over the phone. But when it comes to converting that to a mortgage offer, the lender who offered it fails.
That's because when you request your AIP, a lender will consider only a few things. Don't forget, it's not an official contract.
They'll look at the mortgage you want. They'll then compare your gross income to gauge your mortgage affordability. To get that overview, they'll ask for:
- the basics, your name and date of birth;
- current address and previous addresses if you've lived there less than three years;
- an income and expenditure comparison;
- any existing credit, such as loans, overdrafts and store card agreements.
The inflexibility of most High Street affordability assessments
As a contractor, you'll no doubt use your contract day rate as your income figure. But most High Street branches can only use accounts (for self-employed) or salary.
Your salary will be the amount you process for your tax return. If your accountant is attentive, that’s how much you draw to qualify for stamp. Some lenders may also consider dividends you've drawn.
Either combination is not good! Especially as their calculations don't allow for retained profit.
The knock-on effect
You suddenly find yourself applying for a mortgage based on that tax-efficient figure. The day rate figure that secured your AIP counts for nothing!
Next, the underwriter rejects your application on your salary figure alone.
You have to put all your plans on hold, including any chain you've entered into. You also earn a black mark on your credit file, impairing future borrowing capability.
So contractors have to be vigilant when they get an Agreement in Principle. Make sure the body issuing your certificate understands limited company payment structures. If they don't, stop! Your 'decision' could cause your search for a mortgage more harm than good.