The self-employed face a looming crisis as millions are being locked out of home ownership due to mortgage lenders’ failure to understand their finances, experts have warned.
Contractors, sole traders, gig economy workers, freelancers, and even early-stage start-ups all make up the UK’s 4.8million strong self-employed workforce.
And this number is growing rapidly, particularly among younger workers.
However, a reluctance from banks and building societies to consider the myriad of employment types within this group is creating a ‘computer says no’ attitude to mortgage applications, it’s been claimed.
Three quarters of self-employed borrowers believe it’s harder for them to get a mortgage
The number of 22 to 30-year old self-employed workers across the UK has jumped by a third in the past decade, according to new figures released by the Office for National Statistics.
According to mortgage broker Trussle, most mortgage lenders split the self-employed into sole traders, contractors, partners and small business owners. But they say this doesn’t go far enough.
Trussle’s Ishaan Malhi said: ‘Our way of work is changing but our mortgage systems have stayed the same. What was the homogeneous self-employed worker of yesterday is not the self-employed worker of today and certainly not the worker of tomorrow.
‘Lenders need to be more sophisticated about how they define the different types of self-employed borrowers. Their systems aren’t sophisticated enough to cope with the complexity of today’s self-employed market.’
The lack of granularity is causing many would-be borrowers who work for themselves to run into difficulty when they try to get a mortgage.
Trussle’s research reveals that around three quarters of self-employed borrowers believe it’s harder to get a mortgage because of their employment status.
What’s the problem?
Although it’s not impossible for someone who is self-employed to secure a mortgage, it can be a difficult process because lenders are far less willing to take what they see as a risk on those with a ‘non-standard’ income.
A potential factor in lenders’ reluctance to offer self-employed borrowers is likely to be the spectacular implosion of self-certified mortgages in the wake of the financial crash.
This type of mortgage was designed with the self-employed in mind, allowing borrowers to state their income without having to provide evidence of it.
But they were abused by some in the lead-up to the financial crisis, with many borrowers claiming to have much larger incomes than they had in reality.
As a result many people fell behind on their mortgage payments and lenders lost money.
They were dubbed ‘liar loans’ and, along with sub-prime mortgages, are no longer available.
The problem is that although the employed could lose their job – with perhaps just a month’s notice – their regular monthly income is still seen as a far more stable lending prospect than the self-employed, even if they have relatively high incomes.
Despite having the savings and income needed to pay a deposit and keep up repayments, self-employed workers may be refused a mortgage or offered a smaller loan than employed borrowers simply because their income does not fall into a ‘standard’ bracket – a monthly salary in other words.
Lenders claim the reason for this is it is harder to assess self-employed income, and the risk of fluctuations in the amount and timing of self-employed income means they cannot lend as much to these borrowers.
But the evidence shows that self-employed borrowers tend to be financially cautious.
Research from Kensington Mortgages recently revealed that the average self-employed mortgage customer in the UK could have taken out a mortgage 29 per cent larger than the original loan borrowed.
The problem doesn’t necessarily arise from the fact that lenders think that self-employed borrowers are more risky on the whole than those in full-time employment, but rather that it is more difficult to assess their income.
How are the self-employed assessed by lenders?
Lenders usually take an average of the past two to three years of earnings into account when weighing up whether a self-employed applicant can afford a mortgage.
This isn’t usually the case for contractors, however. Earlier this year Skipton Building Society joined Clydesdale, Halifax, Metro Bank and Nationwide in changing its rule book to make it easier for contractors to get a mortgage.
Most lenders will assess the affordability of contractors according to their day rate.
If you are a partner in a company, most lenders will treat you in much the same way as any other self-employed borrower. They will typically look at your share of net profit when calculating how much you can borrow.
If you’re a director of a limited company then your total income may be made up of a combination of basic salary and dividend payments. Lenders will usually consider both these elements of your income, although exactly how they treat it can depend on your share of ownership.
These approaches differ from lender to lender, and there’s a good chance you could run into some roadblocks during the application process.
You may have good and bad income months or years, some of your equity may be kept in the business, or you could have set up your income in a tax efficient way – all of which will affect how your personal accounts appear to a lender.
If you are self-employed and having trouble getting a mortgage, you can read our How to get a mortgage if you’re self-employed guide here.
What actually counts as self-employment?
Compounding the problems faced by self-employed borrowers is the fact that no-one can seem to agree on what ‘self-employed’ actually means – making it a headache for lenders to categorise how risky these borrowers are.
Within the catch-all term of ‘self-employed’, there are lots of different types of working arrangement that, aside from falling into the ‘self-employed’ category, have very little to do with each other.
Contractors, sole traders, gig economy workers and freelancers will all find themselves pulled under this umbrella. Meanwhile, anyone from founders of start-ups, to plumbers, and directors of large established businesses can all be bracketed as self-employed by a mortgage lender.
Yet the income positions and financial stability of many of these people are likely to be vastly different.
Lenders need to be more sophisticated about how they define the different types of self-employed borrowers
Exacerbating this is the fact that the definition of self-employment also isn’t consistent between the Government, tax authorities and mortgage lenders.
Government and HMRC define a self-employed person as someone who decides their own working schedule, agrees to a fixed price for their work with clients, and can’t be restricted to working for just one client.
Neither HMRC nor the Office for National Statistics could provide definitions for the different types of self-employed workers when approached by This is Money, despite there currently being 4.8million self-employed workers in the UK.
As these different types of self-employed workers have various income patterns, a lender tends to have to look at them on a case-by-case basis to assess how likely they are to be at risk of not paying a mortgage back.
Smaller, specialist lenders can do this, with underwriters trained to read accounts and make decisions, but high street banks are less inclined to – it’s a slower process, harder to do at scale, and as such is not as profitable as a more straightforward loan for someone in full-time employment.
This additional manpower also feeds through into higher mortgage rates for the self-employed.
Self-employed borrowers may not have access to the range of deals those in full time work do
Self-employed borrowers are discriminated against
As they may have trouble securing a mortgage from the big banks and building societies, these self-employed applicants may not have access to the full range of deals that those in full time work have available to them.
Albert Azis-Clauson, founder of freelancer platform Underpinned, said: ‘The cultural, lifestyle, and financial differences between people within the self-employed economy is massive.
‘Because people are all thrown into one bucket, from an occasional driver to a consultant for a high street bank and the thousands of people in between, no-one ever gets the support they deserve.
‘Before any real change can be delivered by policy makers, trade bodies, companies, and individuals, there must be a way of categorising these various types of workers.
‘It must be taken on by major financial institutions and government bodies to set standardised categorisations within the self-employed economy.
‘There is currently no understanding of what the self-employed workforce really looks like, and this must change if it is to be supported effectively.’
How to fix the self-employed mortgage crisis
Sarah Davidson, of This is Money
Sarah Davidson, of This is Money, writes: The plight of self-employed borrowers has been well documented, but little has really been said on what practical steps could be taken to help solve the problems they face when it comes to securing a mortgage.
That’s what This is Money is hoping to change.
Rather than point the finger at the regulator – whose affordability rules, incidentally, are not the issue – we spoke to experts from across the industry at a roundtable hosted by Trussle to discuss what could actually be done to help self-employed borrowers.
I won’t bore you with too many of the details but there were some basic steps that could and should be taken to start to close the gap.
And make no mistake, there is a gap. The way things are today means that lenders have to put hours into underwriting a mortgage application for a self-employed borrower, but a machine can do the whole thing if you have a permanent job.
That translates to lower rates for the employed and more expensive mortgages for the self-employed. In the worst cases, self-employed borrowers are penalised with smaller loans, meaning they can afford smaller properties and they’ll pay more for the privilege than their employed peers.
This is discrimination, and it’s the hard-working Britons in jobs like plumbing, cab-driving, hairdressing, nursing, IT and couriering who are being discriminated against.
Lenders take the view that a person running a business that employs 50 people is a bigger risk than any of the 50 people employed in that same business and will charge them more on their mortgage rate consequently.
It’s not rational. But, what we discovered at this roundtable is that it is understandable.
Lenders need data to build models that assess the risk represented by a borrower. And within the self-employed bracket, that data does not exist.
This is Money is calling for this to be rectified. We believe that as it stands currently, this is an example of market failure and should be reviewed by both the Financial Conduct Authority and the Competition and Markets Authority.
We are calling for:
1. The Office for National Statistics to consult with industry on how to categorise different types of self-employment.
For example, breaking down statistics collected for the self-employed into more granular categories that could include those on zero-hours contracts, limited company directors, private partnership partners, start-up directors, early growth company directors, established scale business directors, skilled professionals, unskilled workers, freelancers, sole traders, contractors – the potential list is long.
2. The Financial Conduct Authority to require lenders to submit lending data through the MLAR regime and include employment status by these sub-categories.
This would facilitate a more granular risk picture to build up detailing how employment status affects mortgage arrears, mortgage defaults, loan-to-values and the proportion of applications that lenders decline.
3. Credit referencing agencies to consider what role they could play in providing more granular data on the personal finances and therefore risk profiles of different self-employed categories.
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