Mortgage applicants who are related to contracting work, have two main ways of arranging their paper work with the service clients. Common method is to arrange a direct contract with the client. Alternative option is to work as an agency worker.
Direct contracts– There is a contract between the client company and the contractor’s own limited company. The client company will pay the contractor directly.
Agency workers– This is an indirect method where a recruitment agency is involved. There is a contract between the recruitment agency and the client’s company. There is another contract between the recruitment agency and the contractor’s limited company.
What does a contractor under IR35 mean?
IR35 is the tax legislation that was introduced to prevent tax avoidance. The law covers contractors operating via a limited company that works very similarly to employees. However, they make tax savings. Her majesty’s Revenue and Customs (HMRC) considers such contractors as “disguised employees.”
It is sometimes difficult to understand the difference between whether a contractor is inside or outside IR35. April 2021, with the introduction of off-payroll legislation, the responsibility in deciding the status will be with the private sector clients. The rules were introduced in the public sector three years ago.
In short, a contractor who operates very similar to a permanent employee is classified as a contractor inside IR35. The client will make the judgment and communicate this to the contractor.
What are the options that are available if you are within IR35?
If a contract worker is within IR35, there are two ways one can continue to be employed:
Umbrella company- This is an arrangement where a contractor becomes an employee of a chosen umbrella company. The umbrella company ensures that all necessary income taxes and National Insurance contributions are deducted before remitting the salary.
PAYE- Under this method, the employer is usually responsible for ensuring the necessary deductions are paid out of the salary.
What are the issues when using an umbrella company or applying for a PAYE contractor mortgage?
High street banks and building societies have traditionally been comfortable with contractors who work with limited liability companies.
Day Rate Contractors operating via a limited company can use their day rate as a base to prove their annual income. The day rate route worked well for the contractors as they were able to borrow even if they were a new contractor with little trading history.
With the IR35 changes, most contractors have to move to an umbrella or fixed-term contract structure. The present mortgage lending criteria with most mortgage lenders are less flexible with these structures.
Is an umbrella company better or a fixed-term contract better?
An umbrella company will employ a contractor under one contract of employment regardless of the number of assignments carried out. Thus reflects a continuous track record of work. This can be advantageous for mortgage applications as high street lenders and building societies may prefer this.
However, the contractor may not have a choice for deciding this. Most clients would not want the administrative burden of a fixed term contract, and therefore most contractors will end up working through an umbrella company.
How do the lenders prove your income?
An umbrella company worker will be treated similarly to an employee, and pay-slips will be required when assessing income. However, the lender will want to see if the contractor has been in the same line of work and can demonstrate they have work lined up for the future.
Umbrella companies will take the contract rates appearing on the contract. The day rates will be broken into minimum statutory pay and the rest of the income in the form of bonus and a commission. The income structure may have to be explained to lenders as each umbrella company uses slightly different structures.
What determines the eligibility?
The new implementation of IR35 has caused changes in the mortgage sphere. Some high street lenders and building societies have been slow in making changes to their lending criteria to accommodate the new change.
Hence, not all the high street lenders are ready to deal with an umbrella company structure. Some lenders consider contractors working under an umbrella company the same as zero-hour employees and will assess the contractors’ income looking at the past year.
Some lenders would consider your day or an hourly rate if you are a high-income earner irrespective of whether they class themselves as Employed, Self Employed, or operate as an Umbrella Company.
Are you moving from a limited company to an umbrella?
Contractors who operate via a limited company are able to use their annual gross contract value into the affordability calculations. The lenders used a daily or the weekly rate earned, multiplied by the predetermined number of days assumed to have worked in a year (this multiple depends on each lender) to enumerate the annual income of such contractors.
If a contractor has joined an umbrella company from a limited company structure, it can help demonstrate continuity.
However, one of the concerns from the lenders’ point of view could be the reduction in disposable income. Therefore, the mortgage lender may want to reduce the mortgage loan.
How difficult is it for umbrella company contractors to go for a mortgage?
Being under an umbrella structure might confuse lenders assessing income and may take a lower income compared to the limited company route. This is because high street lenders and building societies may perceive such mortgage applications to be “riskier.”
A mortgage advisor will discuss the complications with the underwriters of the banks directly if needed, and advise and provide you access to the most suitable product. It is best to connect with a whole of market mortgage adviser. Mortgage advisers would have exclusive offers from banks.
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