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Contractors seeking mortgages must act before interest rate rises, warns expert

Contractors looking for new mortgages or who want to remortgage should take action now, well ahead of any potential interest rate rises that have been hinted at “the turn of this year” by Bank of England Governor Mark Carney.

“If interest rate rises are due in early 2016, contractors who want funding in place before then should be talking to a contractor specialist financial adviser right now,” highlights Taj Kang, mortgages expert at CMME.

“Early engagement is essential as it can take some time to secure a formal mortgage offer from a lender, and the record long-term low interest fixed-rate deals currently available will dry up in the coming months.”

And Kang urges contractors currently coasting on standard variable rates to remortgage quickly as a 2% hike in interest rates will add £467 a month to a typical £280,000 contractor mortgage.

Interest rate normality needs to be redefined

Kang warns contractors that since 2009 when the most recent change in the Bank of England base rate was made, interest rates have been abnormally low: “Normality needs to be redefined. Economists claim that a base rate of around 2.5% is a sign of a healthy economy.

“Carney has hinted that a rise of this magnitude will be introduced slowly over several years so that realistically we could be looking at a 2.5% base rate in 2018. But the new mortgage criteria introduced in the Mortgage Market Review (MMR) won’t be changing any time soon.”

Kang notes that the MMR introduced strict affordability criteria so that lenders look very closely at income and current lifestyle. A rate rise, and correspondingly more expensive mortgages, will make these factors even more important.

How will a base rate increase change contractor mortgages?

By way of an example, Kang calculates that a contractor with a fairly typical mortgage of £280,000 experiencing a 2% increase can expect to pay an additional £467 each month, or roughly £6,000 a year.

“Counter-intuitively, the tougher affordability measures will actually benefit contractors, but only if they work with a mortgage broker who understands contractors and deals direct with lenders’ underwriters who similarly ‘get’ how contracting works,” continues Kang.

“Most of our clients work via their own limited company and 90% of lenders use salary and dividends to define income. A rate rise means traditional underwriting for employees with fixed salaries will be squeezed even further.

“However, contractors applying to lenders using contract-based underwriting should have few problems with demonstrating affordability when rates increase.

Contractors don’t have long to benefit from low rates

Based on what Carney has been saying, Kang predicts that rates will change early in 2016. However, he warns contractors that the markets will react long before the actual rate rise is confirmed.

“The best rates in the market today for contractors add a 0.9% premium on top of the base rate. This is very good because the base rate has been static for so long that lenders have had to chip away at their margins to be competitive and attract borrowers.

Scarcity of funds will drive lenders’ rates. As more borrowers move towards longer term fixed rates, there is less money to lend and so the price of mortgages goes up before the rate actually moves.

“Let’s say the interest rate rise is due in February 2016. The market will react by the end of 2015. Working backwards, it can take several months for contractors to line up the right option and then secure a mortgage offer. So, they should be engaging with a specialist broker right now.”

Lenders’ mortgage rates will be affected by base rate increases

When the base rates do rise, the market changes completely. Kang explains: “If the base rate increases by 0.25%, then lenders will probably increase their rates by 0.28%.

“This is an opportunity for lenders to increase profits in a subtle manner, and this will be particularly true of longer term deals. Those longer term deals will still be there, only they will be more expensive as demand for them increases.”

What does it cost to secure a mortgage or remortgage?

Some contractors may be delaying securing a mortgage, or put off remortgaging because of the cost. But Kang demonstrates that locking-in a low rate deal now more than pays for itself: “Most lenders will charge an arrangement fee, typically £1,000 for better deals, which a contractor can pay up-front or add to their mortgage.

“The new lender is usually happy to pick up the new valuation and legal fees to win the borrower’s business. Then there is the adviser’s cost, and this is where contractors need to be savvy.”

The larger mortgage brokers and financial advisers can charge between 0.25% and 1% of the loan value. For an average contractor mortgage of £280,000, this is between £700 and £2800. Kang warns against using high street advisers: “Few of them understand contractors and they rarely deal direct with underwriters who also understand contractors.”

So, the costs of the mortgage/remortgaging are likely to be in the region of £2,000, but when compared to a potential increase of £467 a month, locking in a fixed-rate for five years now will pay for itself within four months of the rate reaching 2.5%.

Contractors on standard variable rates must act now

Kang is concerned that one group of contractors could get caught out if they don’t act: “Many borrowers’ fixed-rate deals ended months or years ago and so are on their lender’s standard variable rate, but because the rates are so low they have not bothered to look for a new fixed rate deal.

“This group could get caught out in 2016, as lenders will push up the standard variable rate aggressively as that’s where they will take the most profit.”

The other group likely to lose out are those who are waiting for a new property to be built: “There is little contractors can do in these circumstances except have all the paperwork ready so that their adviser can act immediately when the property is a month away from completion.”

Published: 28 July 2015

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