Why your umbrella payslip influences your mortgage application

Reforms to IR35 effective since April 2021 have forced many previously limited company contractors to switch to umbrella companies. And there is a big downside. Compared to employing the payment structure of a limited company (also known as a Personal Service Company), umbrella contractors often find they can’t borrow as much for a mortgage, writes John Yerou, CEO of Freelancer Financials.

You’d think having payslips, albeit from an umbrella company, would make your life easier with a mortgage lender! But no, it doesn’t. Here’s why.

The High Street’s aversion to specialist borrowers

High street banks and building societies struggle to understand umbrella company payment structures. How and why contractors use them as a payment vehicle goes right over their heads (at branch level).

It’s easy to understand why. Take a look at your umbrella payslip and compare it to the PAYE payslips you used to get. As different as cheese and onion. But sadly not as palatable!

It’s not all doom and gloom, though. There are mortgage solutions out there (spoiler: banging the ‘broker’ drum again), as long as you enlist the services of a mortgage broker that specialises in helping professional contractors.

Payment structure, and lender assessment

The key is getting your application to an underwriter who understands your payment structure; that’s the bottom line. Your payment structure is a means to an end, no more than that.

There are two different methods of being assessed as an umbrella contractor for mortgage purposes. The first is contract-based underwriting; the second is using your umbrella payslips.

Contract-based mortgage underwriting for professional contractors

Contract-based underwriting is the least common approach which mortgage lenders use. Conversely, it’s probably the most straightforward method of assessing a contractor’s earnings potential for borrowing. While this has been common practise for limited company contractors for years, only a handful of lenders still use this method for umbrella contractors.

Now, for another banging of the drum if I may. Our business was instrumental in negotiating this method with lenders, and we continue to use it wherever possible. Of the lenders still offering this facility to umbrella contractors, most will only do so through trusted brokers like us.

Positively, contract-based underwriting avoids payslips, notably P60s and SA302s. Instead, underwriters (99% of the time at head office, not in-branch) will assess your relevant earnings based on your gross contract rate alone. This affordability calculation typically provides higher borrowing potential. So, let’s look at an example.

Contract-based underwriting: an example

Take a contractor on £350 a day, contracted to work five days a week. Using contract-based underwriting, such a contractor could potentially borrow around £382,375. Here’s how we work that out:

We take the £350 day rate × 5 (days worked per week) to work out weekly earnings. So, 5 × £350 = £1,750.

Then, we multiply that × 46 (weeks worked per year) to establish an equivalent ‘gross salary’. That’s £1,750 × 46 = £80,500.

Finally, multiply that £80,500 × 4.75 (where 4.75 is the ‘affordability multiplier’), which returns a total borrowing potential of £382,375!

Please note, this calculation is a guide only and the key numbers can vary slightly from lender to lender. Each lender has their own take or criteria, so affordability multipliers, weeks used and impacts like credit score can alter any final mortgage offer.

To get started on how much of a home loan you might be looking at as a contractor, head over to our easy-to-use Contractor Mortgage Calculator.

Umbrella payslips

Using payslips to assess an umbrella contractor’s relevant earnings is becoming the preferred approach by many lenders and their underwriters.

Lenders have always required documents to verify income (don’t mention ‘self-cert’!); the traditional payslip is probably the easiest way of doing this. Along with bank account statements showing the actual net salary credits, lenders and their underwriting teams see payslips as an almost fool-proof way to verify an applicant’s income.

However, this isn’t as straightforward for umbrella contractors! Any seasoned mortgage broker who has seen their fair share of umbrella payslips will confirm this. The average payslip for umbrella contractors shows income broken down into various sections:

• basic salary
• holiday pay
• additional pay
• overtime
• bonuses

More importantly, theses payslip will often show employer NI as well as employee NI and tax -- all in the name of tax efficiency of course. If those aren’t diverse enough for your average in-branch adviser, they also have umbrella companies’ deductions to fathom out!

No one rule for all

If there was one set format that all lenders followed, there might not be an issue. But there isn’t! There is no one rule that all lenders use to determine umbrella contractors’ gross earnings using their payslips.

The good news? A select few lenders won’t distinguish between the description on the payslip, e.g. commission, holiday, basic pay. Instead, they have an underwriting method that uses all of your income.100% of it. They then just deduct the umbrella cost to reflect the correct income for the contractor.

This is in contrast to other lenders who take a more cautious approach. They can and will make further deductions — such as employer NI, holiday pay and in some cases commission — before grossing up your payslip. These lenders want to avoid putting contractors in danger of borrowing a higher mortgage than they could afford to repay in the long term.

Longer service good, offshore schemes bad

That said, a longer umbrella service employee record (typically two years) will open the door to many more lenders for umbrella contractors.

Lastly, one important final note (that doesn’t include any drum-banging, I promise!). We’d urge contractors to please be very wary of offshore payment schemes and ‘umbrellas’ operating ‘arrangements.’ These operators to avoid disguise payments using a ‘loan trust’, ‘bonuses’, or other dubious non-taxable payments which can prevent you getting a mortgage -- period. Compared to what you may save using these schemes, risking the wrath of HMRC and the incontestable position they put you in for getting a mortgage, they’re simply not worth it!

Read more about contractor mortgages here.