Every contractor knows that despite all the wonderful advantages and freedoms of the freelance lifestyle the one disadvantage, in the past at least, has always been that banks and other financial institutions are less keen to open the purse-strings when it comes to contractor mortgages. Consequently, for many years contractors have found that when talking to their bank they hear the same thing over and over again – that the criteria for mortgages streamlines borrowers into either employed or self-employed. However, this does not always work for contractors who frequently employ more complicated tax-efficient pay schemes to manage their earnings.
For High Street lenders such schemes are too complicated for their criteria and they are unable to neatly place them in one of their two underwriting routes. In such instances they will either turn the contractor down completely or they will try to shoehorn them into one of the two categories and will ignore any income that they cannot easily quantify. So, umbrella contractors might find expenses and other contracting pay being ignored and only ‘employed’ earnings being taken into account. This in turn means they are going to be offered much lower levels of mortgage as their affordability classification is significantly reduced, even if their earnings are higher than their salaried counterpart. In addition, banks are often concerned by the end dates on contracts and sometimes view contracts and contractors as unreliable long-term investments.
Thankfully, over the last couple of years things have started to change. Some banks are now (slowly) waking up to the higher earning potential of most contractors and have been adjusting their criteria accordingly. What this means is that with the help of independent financial advisors who know their way around the contractor mortgage market it is now possible for contractors to have access to the exact same types of mortgage and the same rates as can be found on the high street. The lenders now permit this by allowing income to be reviewed according to an annualised multiple of the contractor’s standard daily rate so that their full earnings potential is taken into account. This avoids missing out income that might be sidelined because of repayment vehicles and takes into account the fact that contractors might switch contracts from time to time. Consequently, contractors can choose from the same range of mortgages as anyone else, either as repayment mortgages (wherein the contractor borrows capital to purchase property and straight away starts to repay that mortgage debt) or interest-only mortgages (which can give first-time buyers the option of lower monthly payments, but importantly doesn’t clear the principal and requires a separate investment vehicle to do this later.) These types of mortgage are further divided as follows:
Fixed Rate Mortgages – Sometimes referred to as fixed interest mortgages these are mortgages which fix the interest rate for a pre-agreed period and which then revert to the lender’s standard variable rate. This rate can end up being lower or higher than the borrower’s fixed rate but the advantage of fixed rates is security, knowing what you need to pay each month and that it cannot go up.
Variable Rate Mortgages – These are mortgages which follow the base rate and are divided into a number of different types:
(a) Standard Variable Rates – These are mortgages which follow and fluctuate according to the base rate and which can additionally go up or down a bit more if the lender so chooses. This often means they are good mortgages when rates are high (as the lender might choose to swallow some of the rises in cost of repayment) but less impressive when rates are low.
(b) Tracker Rates – Tracker mortgages are set at a certain level above the standard base rate and then track the base rate religiously, often meaning they are cheaper than the standard variable rate.
(c) Discounted Rates – Like fixed rates, discounted rates are offers by the lender to give the borrower a set discounted rate for a certain length of time (normally one or two years). The lender will discount the standard variable rate by a pre-agreed percentage which will then go back to the SVR at the end of the period.
(d) Capped Rates – Capped rate mortgages are mortgages which follow the standard rate but which cannot increase over a pre-agreed level. These offer security that repayments will not spiral out of control if the rates rise too high.
Flexible Mortgages – Flexible mortgages are, as you would imagine, flexible in how you repay the loan. They permit borrowers to take payment holidays, overpay and make payments according to their financial schedules. The clear advantage of these is that regular overpayments while times are good will significantly reduce the amount to be repaid and the interest being paid on the mortgage. A good option for highly paid contractors.
Offset Mortgages – Offset mortgages are mortgages in which accounts can be linked together and the balance on savings accounts (and current accounts) can be included in calculations when working out interest on the mortgage. Thus, if a borrower has a great deal of savings the interest on those savings will reduce the negative mortgage balance. Useful for contractors who wish to put aside savings for future income tax liabilities.