What income do lenders consider for contractors?

Lenders use specific criteria to assess the income of contractors, which often differs significantly from how they assess permanently employed individuals. Understanding what income do lenders consider for contractors is crucial, as the method used depends heavily on the contractor’s structure—whether they operate through an umbrella company or their own limited company.

Understanding What Income Do Lenders Consider for Contractors?

Contractors in the UK often face challenges securing loans or mortgages because their income streams can be variable and complex compared to traditional employment. While mainstream lenders often prefer consistency, specialist financial services companies recognise that contractual work can offer stability and high earning potential, provided the assessment is carried out correctly.

The primary factor determining how a lender calculates your income is your legal relationship with the payer:

• Limited Company Directors: You are the owner/director of your own Professional Service Company (PSC).
• Umbrella Company PAYE: You are an employee of the umbrella company, which handles tax and National Insurance (NI) deductions.
• Self-Employed (Sole Trader): Less common for high-earning professional contractors, but income is based on self-assessment tax returns.

Limited Company Contractors: Salary, Dividends, or Gross Profit?

The approach lenders take when dealing with a contractor who is a director of their own limited company is perhaps the most varied.

Standard Lender Approach: Salary Plus Dividends

For many high-street banks and building societies, the simplest method is to use the income you have formally drawn from the company. This usually consists of:

• Your annual salary (often a low, tax-efficient amount).
• Any dividends you have declared and paid to yourself.

The Challenge: This method often significantly underestimates your true earning power, especially if you retain substantial profits within the company for tax planning, future investment, or cash flow stability. If you retain £50,000 in the company, that £50,000 is typically ignored by standard lenders, potentially restricting your borrowing capacity.

Specialist Lender Approach: Salary Plus Retained Profits (or Gross Profit)

Specialist lenders, such as those Promise Money works with, are often more flexible and understand the nuances of contracting. They may be willing to assess income based on the company’s overall profitability, rather than just the money you have physically drawn out. This calculation often involves:

• Total pre-tax profits of the company (or gross contract income), before corporation tax, less legitimate business expenses.
• Sometimes, they calculate your share of the net profit, even if that profit was not paid out as dividends.

This approach allows contractors to borrow based on their business’s full financial strength, provided the company accounts are robust and reflect consistent trading history, usually over two years.

Umbrella Company Contractors: Treated as Standard Employees

Contractors who work through an umbrella company have a much simpler route to income verification. Because the umbrella company employs the contractor and processes their pay via PAYE (Pay As You Earn), lenders usually treat this income almost identically to standard employment.

The lender will typically require:

• Recent payslips (usually three months).
• The corresponding P60 form confirming annual earnings.
• A copy of your current employment contract or assignment contract (showing continuity of work).

The main caveat here is demonstrating continuity. While the income is verified through PAYE, lenders will want assurance that the contracting work is likely to continue. A history of successful contract renewals is highly beneficial.

The Day Rate Calculation Method

A particularly useful method employed by specialist lenders, particularly for high-earning contractors, is the day rate calculation. This method is often preferred when a contractor has less than two years of trading history or retains a high proportion of profits within their limited company.

How the Day Rate is Calculated

Lenders calculate your assumed annual income by taking your current daily contract rate and multiplying it by an assumed number of working weeks per year. This usually accounts for holidays and typical breaks between contracts:

• Formula: Day Rate x 5 days x 46 weeks (or sometimes 48 weeks).
• Example: If your rate is £500 per day, the lender might assess your annual income as £500 x 5 days x 46 weeks = £115,000.

This calculation often provides a higher assessed income than the traditional salary-plus-dividend approach, but lenders usually require a minimum contract length remaining (e.g., three to six months) and must see a consistent contracting history, often 12–24 months, even if broken up by short gaps.

For contractors utilising this method, lenders will typically look for the contract itself, rather than complex company accounts.

Key Documentation Requirements for Contractors

Regardless of the method used, robust documentation is essential for lenders to accurately assess your affordability and stability. Missing or incomplete paperwork is a common reason for application delays.

Documentation for Limited Company Directors:

• Last two to three years of certified company accounts (prepared by a qualified accountant).
• Last two to three years of personal SA302 forms (or Tax Year Overviews) confirming self-assessment declarations to HMRC.
• Evidence of the current contract and potentially previous contracts to demonstrate continuity.

Documentation for Umbrella Company/Day Rate Contractors:

• Latest three to six months of payslips and bank statements.
• Current contract showing the day rate and end date.
• Curriculum Vitae (CV) demonstrating professional continuity and experience in the sector.

When applying for a substantial loan or mortgage, lenders need confidence that you can manage the repayments. Part of this assessment involves reviewing your credit history and overall financial footprint.

It is always recommended to review your credit file before applying for credit, ensuring all information is correct and up to date. This gives you the best chance of securing favourable rates.

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The Importance of Consistency and Experience

For contractors, stability is often demonstrated through longevity in the industry, rather than longevity with a single employer. Lenders typically prefer contractors who can demonstrate:

• Minimum History: At least 12 months (and ideally two years) operating as a contractor, with minimal gaps between assignments.
• Professional Background: A strong background in the sector being contracted in (e.g., IT, engineering, finance).
• Renewal Rate: A history of successfully completing and renewing contracts, or quickly securing new assignments.

Even if you are a high earner, a history of frequent, long gaps between contracts may signal instability to a lender, who may then reduce the amount of income they are willing to consider.

Compliance Note on Secured Lending

If the financing you seek is secured against property, such as a mortgage or secured loan, you must be aware of the serious implications of default. Your property may be at risk if repayments are not made. Failure to meet repayment obligations can lead to legal action, repossession, increased interest rates, and additional charges, severely impacting your financial future.

People also asked

How long do I need to be contracting before a lender accepts my income?

Most mainstream lenders require a minimum of two years of consistent contracting history, especially if you are a limited company director relying on company accounts. However, specialist lenders may accept 12 months of history, or even less, particularly if you are an umbrella contractor with a strong professional background and a current contract demonstrating continuity.

Do lenders use IR35 status when assessing my income?

While IR35 status (which determines whether you are deemed employed or self-employed for tax purposes) doesn’t directly dictate the income calculation method, it confirms your operating structure. Lenders primarily focus on the verified income shown in your accounts, PAYE slips, or the contractual day rate, regardless of whether the contract falls inside or outside IR35.

Can lenders use retained profits for affordability calculations?

Yes, specialist and intermediary lenders often recognise the strategic importance of retained profits for limited company directors and will include these funds in their affordability calculations. This approach provides a much more accurate reflection of the director’s true earning potential than simply using salary and dividends paid out.

Will switching from a limited company to an umbrella company affect my mortgage application?

Switching structures can temporarily disrupt your income verification. If you switch to an umbrella company, you will need to demonstrate stability via payslips, often requiring three to six months of PAYE history before a lender will fully rely on that income. It is advisable to maintain your current structure throughout the application process if possible.

What is the Debt-to-Income (DTI) ratio for contractors?

The DTI ratio is calculated by dividing your total monthly debt payments by your total assessed monthly income. While specific ratios vary by lender, contractors generally face the same affordability checks as employees. However, because specialist lenders often assess a higher annual income via the day rate method, contractors often benefit from a better DTI ratio than they would with a mainstream assessment.

Finding Specialist Support for Contractor Income Assessment

Due to the complexity of contracting structures, seeking advice from an independent financial adviser or mortgage broker who specialises in contractor mortgages is usually the most effective route. These professionals understand the various income assessment methodologies and can match your specific circumstances—be it limited company profit, umbrella company PAYE, or day rate—with lenders most likely to offer the best terms.

They can help you navigate the nuances and ensure that your full earning potential is accurately presented to the chosen lender, helping you secure the financing required for your goals.