Interest Only
Contractor Mortgages

Day rate contractors are eligible to apply for interest-only mortgages.  

Not all lenders are contractor-friendly, especially if you are a new contractor. Therefore you may need a specialist contractor friendly high street bank or building society for your mortgage. 

These specialist mortgage providers will adhere to strict criteria in assessing interest-only mortgage applications. 

What is an Interest Only Mortgage?

An Interest only mortgage is what it says on the tin. You pay interest on the loan outstanding until the end of your mortgage term. At the end of the mortgage term, you need to settle the loan in full. 

After the financial crisis in 2008, most residential mortgages have been on a repayment mortgage. This means you pay back part of your loan plus the interest on your loan outstanding every month. 

Interest only mortgage options are limited as compared to repayment mortgages. 

Is Interest only mortgages a good option for contractors? 

An interest-only mortgage can be an opportunity for day rate contractors as you make low monthly payments. However, your loan balance wouldn’t be coming down, which can be a risk for you as you need to settle a lump sum at the end. 

There are different types of interest only mortgages. This includes fixed, tracker, and even offset mortgage products.  

IT contractors can apply for an interest-only mortgage, provided the loan is backed up by a suitable repayment vehicle. 

How does it differ from Capital repayment?

Interest Only MortgagesRepayment Mortgages
Only the interest component of the mortgage is paid every month  Both interest and an element of capital will be paid monthly
At the end of the mortgage term, the entire amount borrowed will be outstanding and has to be settledAt the end of the mortgage term, the whole loan amount will be paid off
Monthly mortgage payments are lower than repayment mortgages.Monthly mortgage payments are relatively higher than interest-only mortgages.
A sufficient deposit and an approved repayment vehicle should be in place to pay off the amount borrowed that is outstanding at the end of the term.    There is no requirement for a repayment vehicle since the capital will be paid off.

Example

Consider a mortgage loan of £200,000 over a mortgage term of 20 years with an interest rate of 1.09%

Monthly Mortgage Payment (Interest only) – £182.57

Monthly Mortgage Payment (Repayment) – £932.48

As per the above, monthly mortgage payments under the interest-only mortgage is very low. However, this would mean that £200,000 will still be outstanding at the end of 20 years.

How does this affect a contractor’s ability to get a mortgage?

Generally, the mortgage repayment option chosen will not affect the mortgage application process. However, there are specific criteria stipulated by mortgage lenders, which contractors need to meet in obtaining an interest-only mortgage.

There will be a minimum income requirement that will be depending based on the repayment vehicle chosen. Some lenders stipulate a £75,000 income per annum and may vary based on the loan to value. As a day rate contractor, your day rate multiplied by the assumed days you work for the year can be used with contractor-friendly lenders. Other criteria will vary across different mortgage providers.

Are there different affordability criteria for interest-only mortgages?

After the 2008 financial crisis, mortgage lenders restructured their approach towards interest-only mortgages. Therefore, day rate or hourly rate contractors will find it challenging to obtain an interest-only mortgage. Banks and building societies follow stringent criteria, and a suitable repayment vehicle is to be in place.

Below are standard criteria surrounding interest-only mortgages.

  • Some mortgage lenders have set the upper age limit for interest only applicants at 70 years.
  • The contractor needs to demonstrate they earn above an individual minimum income level.
  • Mortgage lenders require at least a 25% mortgage deposit if interest-only mortgages are selected.
  • There should be a stable repayment vehicle to pay off the capital at the end of the term. The most common repayment vehicle used by day rate contractors is a sale of a property. 

What repayment vehicles do contractors use for interest-only mortgages?

Most of the high street banks and building societies are comfortable with the sale of property for buy to let mortgages

For residential mortgages, strict criteria surround the sale of the property. A mortgage adviser can help you understand this. 

The other repayment vehicles include,

  1. Sale of a second residential or buy to let property
  2. Bonus
  3. Cash available
  4. Endowment
  5. Pension schemes
  6. Stocks and Shares (including ISA) and other investments

Part interest and part capital mortgage 

This is a hybrid of the two interest only and repayment mortgage. This is popular among contractors and professionals. 

Part of the mortgages loan is only on interest, and the other part will be on a repayment mortgage. This works well for contractors who are unable to show a repayment vehicle to cover the whole mortgage. 

Are Interest only mortgages expensive? 

It is generally not expensive in terms of interest rates and product fees. 

However, since you are not settling the loan, the finance cost paid over the years would stack up to more than a repayment mortgage.

Is interest only mortgages available to IR35 contractors?

Yes. Not all banks offer deals for IR35. However, some lenders would consider IR35 contractors working via their own company, an umbrella company, or a fixed-term contract and may provide interest only mortgages.

Contractors have been working in the public sector since 2017 under IR35. Therefore, banks are familiar with contractors such as locums and IT contractors working under these structures. Therefore, some specialist lenders will be ready to handle the private sector role out in 2021. 

Interest only mortgages may not be suitable for all. A contractor may need bespoke underwriting and interest only contractor mortgage may require a specialist mortgage brokers assistance. Individual circumstances can vary; it is advisable to discuss your mortgage application with your mortgage broker and arrive at a more informed decision. 

As a mortgage is secured against your home or property, it could be repossessed if you do not keep up mortgage payments.