Moving from contracting to perm – how does this affect my mortgage?
There are both pros and cons with mortgages regarding moving from contracting to permanent employment.
We have had plenty of experience in dealing with this issue, as a significant percentage of our contracting clients have recently moved into full-time employment, writes John Yerou, chief executive of Freelancer Financials.
Advantages of moving to perm:
- Wider choice of lenders to apply to
- Documenting your earnings for affordability purposes is more straightforward
But in terms of tangible benefits – things which will make the mortgage application process easier for you, these two are about it I’m afraid!
Disadvantages of moving to perm:
- Lower borrowing potential
- Some lenders want to see a minimum of six months’ employment history
- Potentially problematic to existing borrowers looking to remortgage
Let’s take each one of these disadvantages in turn, so contractors transitioning from ‘off-payroll’ to ‘on-payroll’ know what they’ll be up against.
1. Lower Borrowing Potential
Typically, contractors’ gross contract earnings are higher than their permie equivalents’.
This is a well-known fact and lenders know this too.
Let’s say a contractor on a daily rate of £500 a day approached us for a mortgage. Well, using contract-based underwriting criteria, such a contractor could potentially borrow around £546,250. Yes, as much as that! Here’s how:
We take the £500 day rate × 5 (days worked per week) to work out weekly earnings. So, 5 × £500 = £2,500.
Then multiply that × 46, the weeks worked per year to establish a ‘gross salary’. That’s £2,500 × 46 = £115,000.
Finally, multiply that £115,000 × 4.75 (this 4.75 is the ‘affordability multiplier’), and it returns a total of £546,250!
But if that contractor then moves to permanent employment, it’s highly unlikely that he or she would command an annual salary of £115,000.
2. Minimum employment history
Beware, a number of lenders (like NatWest) want to see a minimum of six months’ PAYE employment history before they will even consider your mortgage application, irrespective of your industry experience!
It’s even worse if you have a gap of six weeks or more between your last contract ending and a new employment contract beginning.
Also, many lenders will not accept your mortgage application if you’re still within a probation clause. If you find yourself in this position, it’s probably best to utilise the services of a mortgage broker.
3. Remortgaging can be difficult
Many first-time buyers max out on their borrowing. Contractors are no different!
This can pose a problem when remortgaging. For example, let's say a contractor engages us having borrowed £437,000 when they were contracting on a day rate of £400. And let's say their two-year fixed rate was coming to an end and they wanted us to remortgage them onto a new competitive rate. Simple, right?!
Unfortunately not. Imagine, the contractor had accepted a permanent position with a salary of £67,000 and even though some lenders might be willing to offer multiples of 5.5, that multiplier can still not be enough to cover the affordability of their mortgage loan. So the affordability gap can simply be too much!
In such situations, we'd look to arrange a ‘product transfer’ with the borrower's existing lender, onto a lower rate. In these less-than-straightforward circumstances, the reasoning behind working with the borrower’s existing lender to arrange a product-switch is to avoid them going onto the standard variable rate.
The April 6th 2021 off-payroll rules might have inspired some contractors to convert to permanent employment, but please don’t make this jump in the hope it will boost your mortgage chances! We say this because too many contractors moving back into employment think that getting a mortgage will be a walk in the park, and that they no longer need a mortgage broker. Unfortunately, neither is true. On the contrary, whether you’re employed, self-employed, or a contractor moving from off-payroll to on-payroll, getting a mortgage is far more complicated today than it’s ever been! Where you do opt for the sensible route and enlist a broker, ensure they don’t miss the plenty of contractor-friendly lenders now offering higher borrowing potential, affordability multiples averaging 4.75 to 5.5, and competitive rates as low as 1 per cent.
Find out more about mortgages here.