How many times have we all heard that it is difficult to get a self-employed mortgage? Or a contractor mortgage?
Even if you earn good money on a daily rate, you may decide to only take out the minimum salary and dividends from your limited company. But this limits your mortgage borrowing according to your bank. Or does it?
Read through the points below and buy your dream home with confidence!
Income assessment for contractor mortgages
The starting point when trying to get a mortgage is to calculate your income.
Here is the good news. You are in the best position possible as a contractor through your limited company. The reason for this is that your income can be calculated in several ways.
Contractor mortgage based on contract rate
And here comes the holy grail for getting a contractor mortgage.
As a contractor, you can get a mortgage based on your contract rate alone. Let me explain.
When someone is an employee, lenders use their full gross earnings to calculate the potential mortgage borrowing.
For company directors, however, it’s not the total company income (i.e. turnover) that is used, but either the salary + dividends or the salary + profit as discussed above. The idea behind it is that companies have expenses related to running the business, which employees don’t have.
Once these business expenses are taken out, then only the profit is left, which the business owner(s) can take out, if they choose to. This is why some lenders accept the profit for income assessment, even if not all of it is drawn as dividends.
However, lenders recognize that most contractors have minimal costs and that most of the earnings are in fact personal income.
Let’s say that you earn £500 per day. This equals to £500 x 5 days = £2500 a week.
A year is 52 weeks long. Accounting for a few weeks holiday or short breaks between contracts and some expenses that you will incur, lenders would use 46 or 48 weeks to calculate your annual income.
Crunching the numbers, your contractor income is taken as £500 x 5 days x 46 weeks = £115,000 per annum (or £120k with a 48-week calculation).
Et voila, most of your income (or even all, if you only worked 46 or 48 weeks during the year) can be used for contractor mortgage borrowing assessment.
Contractor mortgage based on salary + dividends
As a limited company director, the traditional way is to use your salary and dividends. This is also the method that gives the least amount of income.
In addition, most lenders would average the last 2 or 3 years’ figures, which may lower the usable income further.
Some mortgage lenders would use the latest year salary and dividends, while some only do so if it’s lower than in the previous year.
Contractor mortgage based on profit + salary
If you can’t borrow enough with the choices above, you may be able to get more by using your share of the company profit and your director salary. As most people don’t take out all the profit as dividends, the profit figure will be higher than the dividends. This means higher income for mortgage purposes.
Alas, not many lenders use profit + salary for income calculation, so your mortgage lender options will be limited.
Income calculation summary
Let’s summarize your income assessment options by staying with the £500 daily rate (£115,000 – £120k annum calculated income) example.
If this was your limited company’s turnover, then you would deduct director salary (e.g. £11k), expenses and potentially a salary for your spouse.
Let’s say, the deductions leave £70k profit before corporation tax. Deducting 19% corporation tax gives us £56,700 profit after tax and you may opt to take out £30k dividends.
All the above means that your income may be calculated as
- £115k-£120k based on your contractor daily rate or
- £70k profit before tax + £11k salary for you = £81k or
- £56,700 profit after tax + £11k salary for you = £67,700 or
- £11k salary + £30k dividends = £41k
In addition, if your previous year accounting figures were lower, then lenders may average your income over the last 2-3 years.
In short, as a contractor through your limited company, you have access to various income calculation methods. Dependent on how much mortgage you need, a broker can identify the most appropriate assessment method and the most suitable lender.
Income through an umbrella
There are of course contractors who get paid via an umbrella company, who issue payslips and take care of the taxation. When payslips are available for the full income, lenders just assess your case as if you were an employee and take the gross income from your payslips.
Mortgage lending criteria can widely differ in this regard as well.
Some lenders require minimum 2 years contracting history, others are happy with minimum 12 months, while some can even accept less.
There are lenders who require that you had at least one contract renewal or that your contracts are of a certain length.
As a general rule, the longer the history you have, the easier position you are in. This also means that you have more completed business years and finalised limited company accounts, so the above-mentioned calculations based on the accounts can also be considered.
On the other hand, if you change from being employed to being a contractor in the same line of business, some lenders accept a shorter contracting history as well. (For example, a few days.)
Breaks between contracts
As a contractor, you may be on a high daily rate and decide that taking a break for a few months is something you can afford.
Or you might want to spend the summer somewhere nice and sunny or just take 6 months off while extending your house.
In all of these cases, it is your decision to take an extended break. After all, being a contractor and self-employed brings this flexibility. But how does this flexibility affect your mortgage affordability?
When taking a contractor mortgage, i.e. when your income is assessed based on your daily rate, lenders look for stability and sustainability, just like with any other income type.
In other words, mortgage lenders prefer to see no long breaks between contracts during the past 1-2 years. Perhaps it is not surprising, but how do lenders define a “long break”?
Some lenders like to keep things to the minimum and not accept breaks longer than 2-3 weeks. Others are a bit more lenient with 2-3 months.
Anything longer and your lender options become extremely limited.
Admittedly, there are lenders who make exceptions if the break was due to a life event, for example, illness or death in the family instead of just going on an extended holiday.
All this means that a break longer than a few weeks in the 12 months prior to applying for a mortgage will reduce your lender options. In worst case scenario, you may have to wait until you have a year of continuous contracting.
Remaining contract term
It’s not only the history that counts, but also what the future holds when getting a contractor mortgage.
Sustainability may be shown by past track record, but mortgage lenders also like to get reassurance that you are not going to be out of work any time soon.
This may mean a requirement that there are at least 6 months left on your contract, or that at least half of your contract is still to run. Other mortgage lenders are not so bothered and accept past track record as a good enough reference for the future.
If you are getting close to the end of your contract, you may be asked for a signed new contract or renewal agreement. However, in some cases, a letter from the “employer” regarding an intent to renew your contract may be enough.
Sounds vague? Unfortunately, it is. Every lender is different and while some have well-defined mortgage lending criteria, others take a more case-by-case approach.
The good news is that brokers can often pre-discuss and even pre-agree contractor mortgage cases with “risky” situations like a short remaining term.
Taking a second contract
Most contracts are on a full-time basis, i.e. Mon to Fri, 37.5 to 50 hours per week.
Admittedly, some contracts allow flexi-work, so you can work from home and as long as the allocated work is done, no one is checking how many hours a day you put in. This may give an opportunity for a second contract.
If the additional contract doesn’t have defined and controlled working hours and your capacity allows for extra work, why not earn some extra cash?
Sometimes the first contract may not even be full time, so a second part-time contract can easily be added.
If you need both incomes in order to borrow the required mortgage amount, then lenders would typically like to see at least 6-12 months history of working on 2 contracts. This assures them of the long-term sustainability of this arrangement.
At the same time, two full-time contracts are unlikely to be accepted, as working 80 hours a week can hardly be considered sustainable.
In other words, as long as your contracts add up to a full-time job, or perhaps a bit more, and you have some history to show that you can manage both of them, both may be accepted by some lenders.
Just bear in mind that some lenders only accept 1 contract when assessing income based on contract rate. If you have two contracts, these lenders will use your company accounts instead of your contract rate to assess affordability.
Maximum loan to value (LTV)
There can be various factors limiting how much mortgage you may get compared to the property value.
For example, an ex-council flat, a BTL property or borrowing on interest-only basis may see the mortgage amount capped at a certain level depending on the lender. This ceiling may be 75% or even just 50% of the property value.
Similarly, some of the lenders limit contractor mortgages to 70-85% LTV, while others are happy to give even 95% of the property value.
If you do need to use a lender who restricts LTV for contractor mortgages, then you could have your income assessed based on Ltd company accounts instead or based on payslips for those contractors working through an umbrella company.
This, however, is rarely necessary, as a lender without LTV limitation can be found in most cases. Admittedly, sometimes it is in return for a higher interest rate.
You may wonder why the loan to value is restricted. It is all to do with perceived risk when assessing contractors on an hourly or daily rate basis.
Some lenders believe that contractors are high risk, others beg to differ and embrace this form of employment.
Alas, beware that if you had one or more long breaks between contracts, then your case may be approved subject to a capped LTV to factor in potential future breaks.
Proof of income for contractors
Referring back to the first point of this article, there are various methods to assess your income. Be it based on contract rate, Ltd company accounts or umbrella payslips.
Accordingly, the proof of income will depend on which assessment method is used.
Income assessment based on accounting figures will require finalised limited company accounts and/or tax calculation and potentially tax overviews. Or the lender may request an accountant certificate.
However, as a contractor, you also have your contracts and assignment schedules, which show the hourly or daily rate you are on and the full terms and conditions.
If your contract rate is used, the contracts and assignment schedules will be required.
In addition, if you work via an umbrella company, your payslips will be needed.
One thing is for certain, you will have to supply proof of income for your contractor mortgage, so be prepared for it and have fully signed, up to date paperwork available.
A few years ago, there were only a handful of lenders, who could assess contractors’ income based on daily rate. Today there are dozens of lenders, which makes the market more competitive. As an example, another specialist lender has recently joined https://www.peppergroup.co.uk/about-us/latest-news/pepper-money-introduces-day-rate-contractor-calculations.
To get a feel for how differently lenders treat contractors, check out their mortgage lending criteria:
As a matter of fact, these 2 lenders have just agreed to merge, which will create a bigger contractor mortgage lender http://www.mortgagesolutions.co.uk/news/2018/06/18/clydesdale-group-seals-1-7bn-virgin-money-takeover/.