To understand contractor mortgages, you first have to understand contracting. That may sound obvious. But it would surprise you how few High Street lenders are yet to grasp this popular way of working. Or at least it seems that they don’t ‘get it’ at branch level.
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. The reasons? Security and compliance.
The vast majority of mortgages available ‘off the shelf’, lenders tailor to employees/full time workers. That’s the underlying issue that contractors face. A typical contract engagement is far from permanent; often, they’re of a duration of three or six months.
A square peg in a round hole? Not always
Contractor-friendly lenders have appointed specialist underwriters to accommodate contractors’ applications. But you won’t find these teams in your local branch on a Saturday morning. They’re often located at head office and either deal with brokers or their own staff, not the public.
You should also consider that banks remain under the constant scrutiny of ombudsmen and the public eye. As such, they must dot all the i’s and cross the t’s, especially with large loans like mortgages.
Three or six-month contracts don’t provide the security that lenders’ typical mortgage products demand. Thus, the underwriting process that contractors need, you will only find available through specialist brokers.
Contract-based underwriting: the key to your mortgage success
Standard underwriting criteria doesn’t accommodate independent professionals working on continual short-term assignments.
In the vast majority of branches, if you say you’re a contractor, the advisor will pigeonhole you. And often without thinking, that’s how conditioned to their employer’s products they are.
Even if their bank offers a range of mortgages for contractors, a typical High Street IFA won’t be aware of them. They’ll process your information with a view to offering you a self-employed mortgage.
Yes, 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. There is, however, a sacrifice. What your streamlined accounts won’t support is an application for finance, especially a mortgage.
So, today, I want to outline these definitions:
- What a contractor is in the eyes of a specialist lender;
- How contractor mortgages work;
- this includes the underwriting process that underwriters use to calculate limited company contractors’ affordability;
- unlike products for self-employed professionals, contractor mortgages don’t rely on accounts.
What is a contractor in the eyes of a mortgage underwriter?
Contractors work on specific assignments for a set period. The typical duration – or engagement – is 3, 6 or 12 months. This lack of secured employment deters many mainstream lenders from even offering contractors a mortgage.
In many ways, not filling out an application is a good thing. The obvious point is: it’s a waste of time; you don’t fit their ideal applicant’s mould. But there’s a more harmful reason in the background.
This is how a typical contractor’s mortgage application would work in branch.
An IFA will take your details, including a copy of your contract. Now, most limited company contractors earn a deal more than their full-time peers. Upon noting your day rate, the advisor’s eyes light up. On the face of it, that’s a good start.
But then they look at the term of your contract. 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 when the contract ends?
You’d tell them that’s it as far as obligation goes. But, if you’ve done a good job, your client/agency/umbrella company may well offer you an assignment extension.
Now, this advisor/lender is following responsible lending guidelines. With no guarantees of continued employment after your contract ends, your contract may not offer enough security for them. Whether it does or not will depend upon how they interpret the FCA‘s 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.
Why your accounts leave IFAs at a loss
Next, they’ll move onto your accounts. Remember, they’ve worked out your extended annual income based on your day rate. They cannot understand your ‘take home’; why does it look so low, in comparison?
As a contractor, your accountant will ensure that you’re claiming the tax relief to which you’re entitled. Part of that process involves you drawing low salary and dividends. The majority of your income is in the retained profits in your business, but an in-branch advisor will not know that!
They’ll take one look at what you’ve drawn as salary and dividends and use that as the figure to work out your mortgage affordability. Needless to say, 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 and send your mortgage application to the underwriters at head office.
Your payment structure doesn’t do you credit
Given their insight and meeting with you, it’s likely that the IFA will stamp your file “High Risk” before sending it in internal mail. This alone puts the underwriter on alert, but they do the credit search anyway. But because the lender’s interpretation of your affordability doesn’t live up to the value of mortgage you’ve applied for, they reject your application.
That they’ve not taken into account your retained profit matters not at this stage. All the credit agency sees is the amount the lenders assumes you earn and what you want to borrow. Plus what they have on record for you, of course. And you fail.
That big fat fail then remains on your credit report for up to two years. Bad enough in itself, but it also has a knock on effect. That black mark 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, they may just assume that if one of the big four couldn’t get you a mortgage, how are they supposed to? It’s a never ending circle until your credit file is irreparably damaged for the foreseeable future.
This is how a contractor’s mortgage application should work
When you apply for a mortgage through a specialist broker, they already understand your payment structure. You tell them you’re a limited company contractor, they know that what you ‘pick up’ doesn’t reflect your affordability.
They also know how to package your application so that specialist underwriters can see your potential borrowing, too.
On that basis, they’ll ask you for just a few documents. Not accounts. Nor, with the exception of Umbrella Contractors, payslips. In many respects, what you’ve earned in the past 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:
- a copy of your current contract;
- if you only have a few weeks to run, they may ask you to get the promise or even award of an extension from your client or agency;
- a copy of your CV;
- this is so that they can be sure your recent work history is relevant to the field in which you’re now contracting;
- 3-months bank statements;
- this is to ensure continuity of work and that you are earning what your contract says you are;
- proof of ID;
- driving license, utility bill, passport – they need to be sure who they’re lending to.
And that’s all the documentation you need to apply for a contractor mortgage. It’s especially helpful for those new to the lifestyle who’ve not yet built a portfolio or sufficient accounts.
In theory, a contractor with perfect credit can get a mortgage on the first day of his first contract. That’s if:
- their work history is relevant;
- their new contract substantial;
- and have incorporated their company.
Tick all those boxes and even newbies can qualify for the same contractor mortgage underwriting process as contractors who’ve been operating for years.
What type of mortgages are out there for contractors?
Once you get past the gatekeepers and find 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.
Most lenders will try to entice you with a same-day agreement in principle. If they ask you if you want to pull that trigger, make sure that they understand ‘Contract-based underwriting‘. They may be trying to sell you a self-employed mortgage, which is not the same and can lead to a rocky road.
Once you get an agreement in principle, a real one, you’ll find the whole contractor mortgage process refreshingly swift. There are so few documents involved that from application to completion should take no longer than 4-6 weeks.
Yes, it can be a little longer if the lender is running a promotion. But the delay for you will be a lot less than permies going through the main mortgage application process.
With regards to the type of mortgage, there are no limitations for contractors. Fixed, variable and tracker rates are all available. Quite often, you’ll find brokers with direct lines to contractor-friendly lenders run exclusive offers that you won’t find on the High Street.
It takes a long time to build that broker-underwriter trust. But the handful of true specialists who’ve worked with lenders over the years have opened up a whole new market to them. As such, the trust is embedded in the relationship and all parties benefit as a result.
We need to put down the myth about deposits
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.
Prior to 2007 economic crisis, lenders palmed off many self-employed people with 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 weren’t as competitive as those you can now get with a bespoke contractor mortgage. The only way you could reduce the interest rate was to put down more up front, thus lowering the lender’s risk.
In addition, following the MMR, the minimum deposit requirement for interest only mortgages shot through the roof. This was another type of lending that contractors favoured as they could pay off swathes of the balance at contract end. But 40% or even 50% deposits became the least lenders would accept for interest-only mortgages.
Both of these circumstances have led to the misconception that contractors need a greater deposit.
Even independent professionals sometimes need Help to Buy
It remains true that the lower the loan-to-value ratio, the lower the incumbent interest rate. That’s true across the spectrum of the mortgage market. The bigger your deposit, 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 there you have it. Mortgages for contractors are, in essence, no different. High Street lenders will tell you that they are contractor-friendly; 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!
Author: John Yerou
John Yerou is the owner and founder of Freelancer Financials; a trading style & trade mark of the award winning Mortgage Quest Ltd. One of the most recognised names in providing mortgages for contractors and freelancers across the UK.
In 2004 John began his career in Financial Services as an independent mortgage adviser and broker. John has been instrumental in negotiating bespoke underwriting for contractors with high street lenders.
His presence in the industry as a go-to expert is growing by the day and he is regularly cited and writes in publications both locally and nationally.