Contractor mortgages- Day rate / Contract workers/ Umbrella company mortgages explained

Introduction to Contractor Mortgages

Q: What is the focus of today’s podcast?
A: Today’s episode of Let’s Talk Money & Mortgages focuses on contractor mortgages, exploring how affordability is calculated for contractors, who may not have a traditional yearly salary, and how lenders assess their income. Hosted by Gemma, the podcast features Ifthikar, a trained accountant and multiplier with over 10 years of industry experience and a founding director at WIS.

Understanding Contractors

Q: What is meant by a “contractor” in this context?
A: When we refer to contractors, we’re not just talking about construction workers. Contractors include professionals like IT contractors, those in financial services, or finance contractors who work at a client site on a day-rate basis. This is broader than the traditional construction industry contractor.

Contractor Mortgages vs. Regular Mortgages

Q: How does a contractor mortgage differ from a regular mortgage?
A: Traditionally, contractors were considered self-employed, and banks assessed them based on tax returns (SA302s), looking at salary plus dividends, as most contractors work through their own companies. Now, with specialist underwriting, banks use a day-rate basis, multiplying the day rate by an income multiple. This offers more flexibility, allowing contractors to borrow more to buy their dream home. This approach has evolved due to changes like IR35 legislation.

Q: Can contractors still get a traditional mortgage?
A: Yes, contractors can still get a traditional mortgage, but it’s less ideal for high earners. Traditional mortgages look at salary plus dividends, which can be limiting. For tax planning, many contractors take a small salary (e.g., £8,000–£10,000 per year) and dividends within the basic taxpayer threshold. This works for smaller mortgages or less expensive properties but may not suffice for larger loans. The day-rate route is often more advantageous for borrowing larger amounts.

Types of Contractors and Assessment Methods

Q: What types of contractors are there, and how are they assessed?
A: There are three main types of contractors, each assessed differently due to IR35 legislation:
1. Contractors working through their own company (outside IR35): Lenders assess income based on the day rate, offering flexibility to borrow more.
2. Contractors working through an umbrella company (inside IR35): Lenders typically require one month’s worth of payslips (or four weeks for weekly-paid contractors) to assess affordability.
3. Fixed-term contractors: These contractors have a fixed contract (e.g., one year, earning £100,000). Lenders usually require three months’ worth of payslips, and no accounts are needed, making it simpler.
The space is evolving due to IR35, so more changes may come.

Affordability for Contractors

Q: How is affordability calculated for contractors?
A: Affordability depends on the contractor type:
– Outside IR35 (own company): Lenders take the day rate, multiply it by 46 weeks (accounting for holidays and gaps between contracts), then by 5 (days per week) to estimate annual income. For example, a £500 day rate yields a high income figure.
– Umbrella company contractors: Income is annualized similarly based on the day rate.
– Fixed-term contractors: Income is clear from the contract (e.g., £100,000 for a year).
Lenders also consider:
– Expenses: National statistics provide average expenses, but abnormal expenses (e.g., expensive hobbies) are factored in.
– Financial commitments: Loans or credit cards reduce affordability. Banks typically offer 4.5 times your income, but high expenses or commitments lower this. Contractors must manage expenses and commitments carefully to maximize borrowing potential.

Experience Requirements

Q: Do contractors need experience in the same line of work to get a mortgage?
A: Yes, banks require a track record to ensure reliability. For contractors working through a limited company, some lenders accept “day one” contractors with no probation period, but they must have experience in the same field. For example, an IT contractor should have 2.5–3 years of experience in IT (not necessarily as a contractor). This demonstrates professional expertise, as most contractors are consultants.

Personal Expenses and Financial Commitments

Q: How are personal expenses and financial commitments assessed for contractors?
A: Expenses and commitments are assessed the same way as for regular mortgages. Lenders or brokers analyze bank statements to identify:
– Normal expenses: Council tax, water, electricity, and mobile phone bills are standard.
– Abnormal expenses: High expenses, like a £500 monthly phone bill or costly hobbies (e.g., frequent concerts), are treated as commitments, reducing affordability.
– Loans and credit cards: Even 0% credit cards are considered loans. Credit cards are riskier due to potential balance increases, while fixed loan payments (e.g., £150–£200/month) are more predictable. Lenders scrutinize these to ensure affordability.

Credit Status for Contractors

Q: Is credit status assessed differently for contractors compared to regular mortgages?
A: Contractors may be seen as slightly riskier due to short-notice contract terminations (e.g., zero-day notice). While banks don’t openly admit this, credit scores may be evaluated with stricter criteria. A good or excellent credit score (e.g., 750–800 on Experian) is ideal for securing favorable rates, though some banks are more lenient. Hidden issues, like missed payments, can impact approval despite a good score, so a detailed credit file review is crucial.

Required Documentation

Q: What documentation do contractors need to apply for a mortgage?
A: Required documents depend on the contractor type:
– Limited company (outside IR35): The contract showing the day rate is key.
– Umbrella company (inside IR35): At least one month’s payslips (or four weeks for weekly pay).
– Fixed-term contractors: Three months’ payslips and the contract.
Common documents include:
– Personal bank statements to assess expenses and commitments.
– Company bank statements (if applicable).
– Proof of residency (e.g., passport, proof of address) to confirm UK residency or right to work.
– A CV to verify experience in the same line of work.
– Occasionally, a P60 to confirm work history.
Lenders use these to ensure income stability and professional consistency.

Applying as an Inside IR35 Contractor

Q: Can contractors working inside IR35 apply for a contractor mortgage?
A: Yes, but “day one” contractors face challenges:
– Umbrella company contractors: Require one month’s payslips (or four weeks for weekly pay).
– Fixed-term contractors: Need three months’ payslips and a contract.
– Deemed employees (inside IR35, working through a limited company): Assessed like outside IR35 contractors, based on the contract. This is a growing trend, making it easier for them to secure mortgages.
Day one mortgages may not be available for umbrella or fixed-term contractors due to these requirements.

Contracts Nearing Their End

Q: How does a contract nearing its end affect a mortgage application?
A: Banks are lenient, as three- or six-month contracts are common. Generally, you need at least six weeks left on your contract when applying, as lenders want assurance you can make initial mortgage payments. If you’ve worked as a contractor for at least one year, some banks may impose additional conditions. If the contract has less than six weeks left, lenders may assess based on SA302s (salary plus dividends) or company accounts, but this may limit borrowing compared to the day-rate method.

Interest Rates for Contractor Mortgages

Q: Are interest rates for contractor mortgages higher than standard rates?
A: No, interest rates are generally the same as for standard mortgages. For example, Halifax offers the same 2% rate regardless of the mortgage type. However, new contractors may have fewer lender options, as some banks don’t accept them. Contractor-friendly banks may have slightly higher rates than the best market rates, but high street banks are increasingly contractor-friendly, offering competitive rates even for new contractors. Experienced contractors are likely to secure the best rates available.

Final Advice and Considerations

Q: What should contractors keep in mind when applying for a mortgage?
A: Not all points discussed apply to every borrower, so consult an advisor to confirm eligibility. WIS’s contact details are available for assistance. Remember, a mortgage is secured against your home, which could be repossessed if repayments are not maintained. For further inquiries, reach out to a professional advisor to ensure the best mortgage solution for your situation.

This Q&A structure maintains all original information, enhances readability with clear headings, and organizes the content for easy understanding. Let me know if you need further refinements!