Many limited company contractors are quite understandably, left feeling confused regarding how mortgage lenders will assess their income.
This updated 2024 mortgage guide aims to dispel that confusion.
We'll explore the different ways banks and building societies treat contractor income for mortgage affordability.
You'll also discover how long you need to be contracting before applying and the many other criteria surrounding mortgages for limited company contractors.
What is a limited company contractor?
A limited company contractor is defined as a company director employed on a fixed, short-term or non-permanent contract who receives their income into a limited company.
Sometimes referred to as a Personal Service Company (PSC), contracting as a director of a Limited company is a tax-efficient business structure for solo IT and other contractors. It also provides greater credibility to prospective employers.
Of course, unlike an umbrella contractor, it also means you're responsible for submitting company accounts, paying corporation tax and abiding by the legal requirements and obligations of being a company director.
Can I use my day rate instead of dividends or net profit?
Yes, depending on your contracting history, and income level, it may be possible to use your day rate rather than salary and dividends or salary and share of net profit.
Eligibility criteria around the use of day rate vary from lender to lender.
For example, some only allow the contractor's day-rate to be used where a minimum income threshold is met. Others require a minimum amount of contracting experience, usually at least 12 months.
Being assessed as employed for income verification
Other eligibility criteria may apply. If met, the applicant can then be treated as employed for income verification purposes and the day-rate used.
Otherwise, the lender's self-employed mortgage criteria applies and either salary and dividends or salary and net profit is used.
Calculating a limited company contractor's income
For a couple of reasons, calculating income from the contractor's day rate (sometimes referred to as contractor-based underwriting) is generally preferable.
- It usually allows the applicant to borrow more.
- There's usually no requirement to provide one or more year's Limited company accounts or personal tax calculations/SA302s.
How is income assessed using day-rate earnings?
To calculate a gross contract value (GCV), a.k.a annualised gross income figure, most lenders use this formula:
Contractor day rate x 5 days a week x 46 weeks a year. Or, more simply, day-rate x 230 days a year.
A few lenders use 48 weeks or 240 days a year, allowing you to potentially borrow more.
Of course, if your contract states you are contracted to work fewer days per week, then the calculation will be amended accordingly.
Where the number of days or hours worked aren't stated on the contract, the role is assumed to be full-time, 5 days a week, as long as the income showing in the business bank statements evidences this.
If the contract states an hourly rate, some lenders will multiply it by eight hours, others seven. Then the daily figure is multiplied by 5 days and either 46 or 48 weeks.
Assessing income with GCV or latest months's revenue
Some lenders use the lower of the Gross Contract Value or the annualised income amount based off your latest month's business bank account income.
This is an important point to consider, as it can materially affect your maximum borrowing amount if you've worked less than you normally would in the latest month.
To calculate your annualised income from the latest month's business bank statements the formula is:
latest month's revenue x 12, divided by 52 and then multiplied by 46.
