Posted by John Yerou
on October 30th, 2015 12:22pm in
Last Updated on December 23rd, 2018 17:45pm.
Estimated Reading Time: 8 minutes
It’s thanks to the IT crowd that bespoke mortgages for contractors exist. As banking systems digitalised, banks outsourced specialists to update their systems.
What these banks discovered was that:
- IT professionals capable of rebuilding their digital ecosystem from the ground up earned big money;
- despite that high income, banks had little in place to accommodate an IT contractor’s mortgage needs.
For one or two lenders, they spotted the instant opportunity. It was a lucrative, growing market that they were missing out on. And it’s not like technology was (or is) going away.
In fact, IT specialists will be in even greater demand. Experiments in building a generic global banking system in line with Bitcoin software assure this. So, have all High Street lenders adopted lending policies tailored to this dynamic market?
It’s been over a decade since the first banks catered for IT contractors. Yet there remains only a handful of mainstream lenders providing mortgage products for them today.
True, we can’t overlook the part the Credit Crunch played. The old ‘self-cert’ mortgage – a fall back for many lenders – has gone for good.
And self-employed mortgages? They rely on accounts. That’s great for contractors who’ve been trading for years. But they’re no substitute for newer contractors operating through a limited company.
So, what IS the answer?
No matter how you work, buying property remains one of the safest investments anyone can make. That’s true whether you want to:
- put a roof over your own head and that of your family;
- top up your income today, with a view to future financial security.
But with so few High Street lenders accommodating contractors, how can you make either happen?
Your first port of call is to find a specialist broker who understands contracting. But beware. Many lenders say they’re contractor-friendly, but can only offer mortgages using accounts.
Ask them if they deal direct with underwriters who know the nuances of your contract. Without such knowledge, a lender won’t offer a mortgage that befits your annualised income.
What’s an IT contractor’s annualised income?
It’s what your equivalent salary would be if you multiplied your day rate over a year. It’s a lender’s way of gauging a representative salary. So, let’s do the maths.
If you’re an IT contractor earning £350/day, you’d earn £1,750 a week. Most lenders use 48 weeks as the yardstick. Over a year, that means your annualised income would extend out to £84,000.
That’s not the maximum you can borrow; far from it. Each lender has their own ‘affordability factor’. That’s the amount by which they’ll multiply a ‘salary’ to work out the size of mortgage an applicant can afford.
For IT contractors, the typical multiplier is 4.5. So if you’re notching up that £84,000, you’d multiply it by that 4.5. Thus, a contractor-friendly lender would offer an IT contractor on £350/day a mortgage of around £378,000.
The Fab Four Mortgage Types for IT Contractors
Once you pass these hurdles, you can start to think about the types of mortgages available for mortgage IT contractors. These are:
- Repayment (Capital + Interest);
- Interest Only;
A repayment, or capital and interest, mortgage does what it says on the tin:
- you borrow ‘x’ amount from the bank to buy your home (minus your deposit);
- you use your home as security against that loan;
- you make monthly repayments that pay both interest and the loan amount.
This method is by far the most popular for both salaried workers and contractors. It guarantees that they own the home at the end of the mortgage term.
Borrowers make regular repayments, often over 25 years, until they’ve repaid the lender the full loan amount. This includes interest, charged as agreed during the mortgage application process.
Why repayment mortgages aren’t the only option
Repayment mortgages can and do work for contractors, too. But an IT contractor’s income can fluctuate throughout the year.
If you choose a repayment mortgage, consider building up a ‘float’ when you are working. This is great advice for everyone, not just contractors. It will also ensure continuity of your repayments for those times you’re out of contract, whether by choice or not.
Interest Only Mortgages
In the eighties, interest only mortgages were as popular as repayment mortgages. The theory was simple.
You borrowed the money from your bank to buy your home. You only paid the interest on that loan, but you also bought an ‘endowment’ policy.
The intention of that policy was to accrue as much as the value of your mortgage loan, if not more. In the early days, it worked well.
The problem was – and is – that money markets fluctuate. The factors investment policies need to make them work can be present one day, but gone the next.
In the end, the fee structures also undermined the end value of these products. And true to form, other detrimental factors became present and affected interest only mortgages.
After the credit crunch, interest rates shot up on interest only mortgages. Lenders differentiated between repayment and interest only mortgages to ensure that they became very different products.
They also adopted a stricter line on what classified as a repayment vehicle to pay off the mortgage. More on that below. But the smallest interest only deposit lenders required (from anyone) rose to 25% or even 50%.
Don’t get caught sitting on a timebomb
If you’re of an age, you’ll remember the mass media campaign that followed the housing boom bust. For several years, the FCA and mortgage lenders warned existing mortgagees that they could be sitting on an ‘interest only timebomb’.
In essence, the whole market had to be re-educated. So today, repayment vehicles must be both pre-existing at time of application and they have to work. If neither of those conditions are met, lenders won’t grant anyone a mortgage on an interest only basis.
The result was that many people abandoned their endowment policy and switched to capital and interest mortgages. Our suggestion for interest only ‘prisoners’ is this; either:
- switch to a capital repayment mortgage likewise;
- contribute into an ISA.
But do be aware that there are two basic types of ISA.
One is the cash ISA, which is little more than a savings account. Then there’s also the equity ISA. These have continued to perform even as interest rates have plummeted. It’s this latter savings vehicle that you should consider.
Pension mortgages offer an alternative way for IT Contractors to buy a home using interest only. However, things have changed.
Lenders will now only consider the 25% that you can draw down at retirement age tax free to repay any mortgage balance. This makes sense, as it leaves you with the 75% to live on in retirement.
Like other investment mortgages, your pension must perform and it must already be in place. You can’t apply for an interest only mortgage and take out a pension at the same time to support it. But the concept itself is simple enough:
- you pay into your pension (utilising limited company benefits, you can save tax here, too);
- once you’re eligible to draw your pension, you pay off your mortgage with 25% of the proceeds.
As an IT contractor, your earnings are higher than your permie peers. Plus, your accountant will have encouraged you to pay your pension through your limited company. As such, these mortgages are a potential goldmine.
Why haven’t I heard of pension mortgages?
A permie pays pension contributions and mortgage repayments after tax. As a limited company IT contractor, you’re much more tax efficient.
This means you can pay much more of your mortgage loan using income that’s been subject to tax relief. Or at least income that would otherwise attract higher taxation.
But it’s worth pointing out again. How much you draw down from your pension will affect its future performance.
Which option is right for me?
There’s no definite answer to which is the best mortgage repayment method for IT contractors. Much will depend upon your:
- existing circumstances;
- age/how long until you retire;
- payment structure;
- income, savings and investments.
What we must iterate is that mortgage lenders want security, hence a repayment mortgage is often the best way. That’s not just to ensure that you will pay off your home. Repayment mortgages also show that you’re serious about owning your home.
Even if you’re earning ten times as much as a permie, getting a lender to see your true income is key. Yes, we can prove affordability based on your contract alone. But you may have underlying factors that affect your best route to home ownership.
Other factors that shouldn’t be in the small print
Just because you’re a super-intelligent IT Contractor doesn’t mean that you’re brilliant at everything. Like most people, you need help when it comes to investing in a property. You want to make sure that the biggest outlay of your life offers a working mechanism right for you.
Venture onto the High Street and most lenders will offer you a self-employed mortgage. This involves accounts, trading history and is akin to a permie’s mortgage.
If you’ve been an IT Contractor for years, your accounts may well get you by. The likelihood is that they’ll provide the information a lender’s looking for.
But – and it’s a big but – the IFA you speak to? They may also tag your application as high risk. Some lenders apply such a status to the self-employed as a matter of course before sending their documents to the underwriter.
And that’s where the IFA – or bank’s lending criteria – misjudges contractors. In truth, you’re no more high risk than an in-demand, salaried IT professional.
As an independent professional, your real strength lies in those attributes. They should help you secure a mortgage, not prevent you from getting one!
You’re as competent as a permie, but with added flexibility. An engager can hire you for the term of your contract to get the job done. But they don’t have to find you a more demeaning task once you’ve accomplished what it is they hired you for.
Yes, they may well pay a premium for your services. But once you’re done, you’re done, obligation ended.
Agencies, contractors and employers can see this. But High Street lenders? They have no system in place to accommodate working this way.
Introductory Rates and Redemption Charges
All mortgages come with a preferential ‘introductory’ rate. Once that term is over (anything from 2-10 years, depending upon lending conditions), the loan will revert to the bank’s SVR.
A lender’s variable rate can be higher or lower than your introductory rate. Often, the Bank of England’s base rate will affect the market’s SVRs.
To ensure they make at least a small profit, most lenders have ‘buy out’ clauses. This will come into effect if you end the mortgage before the introductory rate end date.
Banks and Building Societies refer to this fee as the early redemption charge. So if you think that you may move before the introductory rate ends, you may incur this charge.
Depending upon the lender and how far you are into the introductory term will determine the amount you could pay. As such, you should always consider your options.
A new ‘introductory term’ can help save you money with a remortgage. Yes, you don’t even need to move home to make this saving. Check with your specialist broker, whatever your contracting or homeownership status.
Take control of your own destiny
You don’t have to buy a costly ‘payment protection’ clause, as many lenders will offer you. When you set out in business, you’ll have realised that you need your own cover.
Typical payment protection policies don’t cover the way contractors work. Speak to your specialist mortgage broker if you’re unsure of the cover you need.
You don’t have to use accounts to secure the mortgage your earnings deserve. You’re an individual who’s set out in business under your own steam. You’re an IT Contractor who can make a bigger difference offering your services ad hoc than working for the man.
So, yes: you want a home that reflects those bold intentions and a lender who can make that happen.
Now’s the time to take control of your own destiny. Supervision, direction and control is coming. It may even place the power of your income into the hands of your client.
You know what your services to the IT sector are worth, as do we. But you DO need someone like us to show them to those less contractor-savvy.
You have a real opportunity to use your potential income as leverage. Don’t let the high street palm you off because they can’t see it.
Author: John Yerou
John Yerou is the owner and founder of C&F Mortgages; a trading style & trade mark of the award winning Mortgage Quest Ltd. One of the most recognised names in providing mortgages for contractors and freelancers across the UK.
In 2004 John began his career in Financial Services as an independent mortgage adviser and broker. John has been instrumental in negotiating bespoke underwriting for contractors with high street lenders.
His presence in the industry as a go-to expert is growing by the day and he is regularly cited and writes in publications both locally and nationally.