Making the decision to purchase a property, whether that’s your first home, or if you’re planning on moving up the property ladder, is a huge and exciting step.
It can be made more complicated when you throw into the mix that you’re a self-employed contractor, and you don’t have what some banks/lenders view as a ‘stable-income’.
In the past, this could be a stumbling block, but as contracting has become more established as a career choice, banks and mortgage lenders have started to relax their requirements around lending to contractors.
Yet, many contractors still have concerns about applying for a mortgage. This guide aims to dispel the myths that surround applying for a contractor mortgage. So, you’ll feel confident when you next come to apply for a mortgage.
This guide will cover:
- The types of mortgages that are available
- How much you can borrow
- What paperwork you’ll need to provide to the lender
- Tips to make the application process easier
Buying a property is among one of the biggest decisions you’ll make and by far the largest financial commitment. So, it’s important you understand the process and are confident that you’re making the right decision.
Types of mortgages that are available
One of the first steps in applying for a mortgage is deciding what sort of mortgage is right for you. There are several products on the market, the main ones you’ll likely come across are:
- Repayment mortgage – over the length of the mortgage term you’ll steadily be repaying the amount you borrowed, plus the interest added by the lender. In the end, you will have cleared what you borrowed
- Interest only mortgage – with this type of mortgage you aren’t actually making repayments towards the amount borrowed. Instead each month, you’re repaying the interest due on the amount you borrowed
- Fixed rate mortgage – the mortgage lender guarantees the interest rate applied to the amount you’ve borrowed will be fixed for a specific time. This can be anything from one to ten years. At the end of the agreement, the rate will be switched to the lenders default SVR rate
- Standard variable rate (SVR) mortgage – this is the lenders default interest rate and one which people typically find themselves on after finishing their introductory rate. You can also take out a standard variable rate mortgage, but they tend to very expensive
- Discount mortgage – over a specified period, you can get a discount on the lenders default SVR. This means that the amount you’ll repay each month may change, depending if the lender changes their SVR
- Tracker mortgage – the interest rate you pay on the money borrowed is linked to an external rate – this typically tends to be the Bank of England’s base rate, plus a set percentage. The amount you repay each month may change depending if the external rate changes
- Capped mortgage – this type of mortgage is typically offered as an introductory mortgage. The interest rate applied to the amount borrowed is capped, so your repayments won’t go above a certain amount. The interest rate tends to higher than what is offered with a tracker mortgage
- Cashback mortgage – when you sign up to a mortgage, the lender pays you a lump sum based on an agreed percentage of the amount borrowed. This can range from one to seven percent. This type of mortgage can be useful if you need cash to put towards purchasing things for the property, but you may find that restrictions are placed around early repayment of the mortgage
- Flexible mortgage – these types of mortgages usually have terms that allow you to overpay and underpay and even take payment holidays (miss a few months of repayments). This type of mortgage is best suited to people who want to have greater control over how much they repay each month. But this flexibility is counterweighted by higher interest rates
- Offset mortgage – allows you to offset your savings against the amount of interest that you pay. To do this, you’ll need to open a savings account with your mortgage lender and link it to your mortgage
How much you can borrow
You’ve found your perfect home, and now you’re keen to get the process moving. But, it’s important to understand that this process can’t be rushed. The mortgage lender will first perform an affordability assessment. This involves reviewing your income, expenses and income security.
As well as being used to determine how much to lend you, mortgage lenders also use affordability assessments as a way to decide if you’ll be able to honour the mortgage repayments for the whole duration of the mortgage.
Lending money is a big risk for lenders, and they want to be as sure as they can that they won’t lose out. Coming to this decision involves ‘stress-testing’ your finances.
A stress test assesses how your finances will cope if your circumstances change. For example, you have a child, or if your mortgage repayments increase. To do this, they look at your current lifestyle and spend on things like entertainment, shopping and holidays, and calculate the possible financial impact of these changes.
Calculating the salary of a self-employed contractor isn’t as straightforward as working out the salary for an employed person.
Mortgage lenders are aware of this, so they have several methods they use. One way is to look back at what you’ve earned over the last few years and average it out. As an example:
£60,000 (2017 earnings), £62,500 (2018 earnings) and £65,000 (2019 earnings). Average = £62,5000.
The mortgage lender may not be keen to use this approach if your income has fluctuated in recent years. The worst-case scenario is that they may use your most recent years’ earnings or the lowest amount as the base to calculate what they’ll lend you.
What happens if I work on a day rate?
If you’re working on a day rate, then the lender may be willing to calculate your annual income using this, but they may state that it has to be a minimum of a 12-month contract. They usually use the following formula to work out your annual income:
Day rate x number of days worked each week x 48 weeks (this considers time not worked for holidays etc.)
This method may work better for new contractors who don’t have a long history of contracting. However, it’s important to note that the mortgage lender may ask for a copy of your contract as proof, so keep a copy handy so you can send it to them.
I work through a limited company will the lender take the same approach?
It’s common for contractors to work through a limited company as it’s the most tax efficient way to work. If this is how you operate, the mortgage lender may calculate your annual income on what you take as a salary but not dividends. This can become a problem if for tax purposes you decide to take a small salary.
However, there are specialist lenders who may be willing to lend you money based on the information they find in your accounts.
Before renewing your mortgage or applying for your first mortgage, give your accountant plenty of notice so they can make sure your accounts are up to date and accurate.
As part of the affordability assessment, the mortgage lender will need to see details and proof of your monthly expenses. This will involve providing a copy of bank statements and, or credit card statements. Some lenders may require six months’ worth of statements, whilst others may ask for statements dating back longer.
They’ll be looking for details on things like; credit card debt, loan repayments, child/spousal maintenance payments, school fees, travel expenses and bills, such as Council Tax and utility bills.
Assessing your income security
Some lenders sadly still take the view it’s risky lending money to self-employed contractors, because of the perceived instability around your income.
So, you may find that your application gets referred to an underwriter. This is someone who looks at your income, expenses and credit score amongst other things to assess the level of risk involved with lending you money.
We advise contractors who are applying for a mortgage to provide as much information as possible. Your accountant can be a great source of support at this time, as they can provide accurate and up to date information on your income.
Copies of paperwork you’ll need to provide
The process of applying for a mortgage for an employed person versus a self-employed contractor, is pretty similar, apart from that a contractor will have to provide more evidence of their income.
The paperwork a mortgage lender may ask for includes:
- 2/3 years of certified accounts that have been prepared by a qualified accountant (another reason why it’s important to engage with an accountant!)
- Evidence of your earnings via form SA302, or copies of tax reviews from HMRC for the last 2/3 years
- Copies of upcoming contracts
- Evidence of dividend payments or retained profit held withing the limited company
If you’re relatively new to contracting, it’s likely that you won’t have 2/3 years’ worth of accounts and income. While this may make it more challenging to get a mortgage, it’s not impossible. Although you may find that the number of mortgage lenders who are willing to lend to you is reduced.
You’ll also have to provide proof of your identity. This involves supplying copies of:
- Passport/driving licence
- Council tax bill
- Utility bills dated from within the last three months
- Bank statements going back for the last six months, or longer
Tips to make the application process easier
When a contractor mentions that they are looking to apply for a mortgage, one of the first bits of advice we give is to ‘get yourself in a good position’. This means having your finances in order and all your paperwork up to date as this will make it easier for you to be approved for a mortgage.
Look forward to relaxing in a home you own, with these top tips for getting a mortgage:
- Find a mortgage broker or IFA (Independent Financial Advisor) who has experience in arranging mortgages for the self-employed. Not only will they know which lenders to look at, but it’ll save you time hunting for them yourself
- Be honest with your mortgage broker about any debt, outstanding loans or CCJ’s you may have as they’ll need to know about these before searching for mortgage lenders
- Have a good credit record – things like missed credit card repayments, missed bills and CCJ’s all count against you. Surprisingly, if you’ve never taken credit e.g. never had a loan or a credit card, this can also hurt your credit rating
- Keep clear and accurate records – the lender will ask for proof of your income. Depending on how you work they may ask for copies of your work contracts or 2-3 years copies of filed accounts. Do engage with a certified and experienced contractor accountant and have a copy of these documents to hand so as not to hold up the mortgage application
- Curb your personal expenses – as part of the mortgage application, the lender will review your outgoings to determine what you can realistically afford to borrow. If you know that in 6-12 months’ you’ll be looking to get a mortgage, review your expenses to see if you can cut back on unnecessary expenses
- Save a large deposit – You’ll need at least a 10% deposit, but a larger deposit will give you access to better interest rates
If you’re an SG Accounting client and would like to engage the services of a qualified mortgage broker or an Independent Financial Advisor (IFA), we’ll be happy to connect you with people who understand the unique needs of contractors. Just give your Personal Accountant a call.
If you’re not an SG client but would like the kind of service that takes into account all of your financial needs as well as offering a great contracting accounting service, give us a call 01932 867550, or send us a message.