Dear Dippy Mr Strummer has been a self-employed IT consultant for just over two years. His accountant has been depreciating new equipment costs so his net profit is low. Mr Strummer earns about £40,000 a year. He wishes to remortgage but wants to raise extra capital for home improvements and computer equipment. His property is valued at £185,000 and the outstanding mortgage is around £120,000. What are his options?
Dippy says: This case throws up interesting questions about using a mortgage to subsidise business finances. To offer advice we have Peter Brodnicki of the Mortgage Advice Bureau and Colin Barrett from BM Solutions.
Peter Brodnicki, chief executive of Mortgage Advice Bureau
As Mr Strummer is self-employed and his accounts do not show a true reflection of his earnings we would recommend a self-certification mortgage for him. This means the lender would not require any evidence of earnings from his accountant. Once we had properly established affordability and suitability Mr Strummer would be asked to declare accurate information regarding his true income on the mortgage application form.
We would conduct a strict affordability assessment with the client based initially on what the current repayments would be at the standard variable rate.
It would also be important to ensure that the client understands the financial consequences of a subsequent rise in interest rates.
In order for us to do this Mr Strummer would be asked to provide accurate information concerning his income and his outgoings. We would then recommend a lender that offers a fee-free remortgage so as to enable the transaction to be carried out free of charge.
Mr Strummer should be looking for a lender who will not charge any arrangement, booking, valuation or legal fees.
A flexible mortgage would be ideal for this client as this sort of deal would allow him to make cash withdrawals from the mortgage as and when required.
As well as being convenient, it would also be costeffective as it would mean that Mr Strummer would not incur any extra interest charges on the amounts raised until the funds were actually required.
The client would have the facility to borrow up to 85% of the value of the property and could request the funds in tranches as and when required.
This type of mortgage would also allow him to make overpayments so that if he has a higher income during a particular month he could take advantage of this to reduce the mortgage amount.
Of course, a flexible mortgage option would also allow Mr Strummer to take advantage of payment holidays or make underpayments – by prior arrangement with the lender – if he had any cashflow problems due to his being self-employed.
As interest rates are currently so low, I would suggest that Mr Strummer chooses a mortgage that tracks the Bank of England base rate so that he can keep his payments down.
Colin Barrett, senior product manager, BM Solutions
Being self-employed, Mr Strummer is likely to have a variable income and might have difficulty proving his income to the level required by mainstream lenders. He may get paid in large lump sums at the end of a contract and consequently may be without a regular income for a number of weeks. Alternatively he might receive large work-related bonuses. More and more workers are turning their backs on the nine to five grind to work as freelancers or contractors. Others are forced towards self-employment because of redundancy or a change in their personal circumstances.
It is quite possible that Mr Strummer is involuntarily self-employed. After the dotcom boom and the downturn in technology stocks, many IT professionals turned to freelance consultancy. This has driven the success of the selfcertification sector.
Any broker dealing with Mr Strummer would need to be confident that his estimated earnings were viable and realistic. With self-cert the customer certifies his or her own income. Therefore the broker would also have to emphasise to the customer that stating an incorrect salary on an application form is fraud. Under MCOB section 11 a lender has a responsibility to ensure that the loan is appropriate and affordable. For example, lenders will stress-test applications against a base rate way above the long-term average of 5%. A range of automated checks will also be carried out drawing on data from credit search providers such as Experian.
Before taking on any loan the client must feel confident that if for any reason his industry hits hard times, he has a contingency plan in place to ensure that he doesn't fall behind with payments. It is always wise for borrowers to have a pot of cash that can be easily accessed in a financial emergency. He should also be sure that securing a loan on his home for business purposes is the right thing to do.
If he does decide to proceed with his remortgage, a BMS flexible product would best fit Mr Strummer's needs. Because his current loan of £120,000 represents a loan-to-value of 65% he could borrow up to £130,000 on his declared income with BMS giving him an additional £10,000 to use. This would also mean he could get a sub-75% LTV product such as the Bank of England base rate plus 0.89% deal for three years. This is a flexible product with overpayments and underpayments, offering him the flexibility to manage his finances through peaks and troughs. These kinds of flexible deals are ideal for customers like Mr Strummer. He can also pay off lump sums, reducing his debt but building up a fund to draw back should the need arise.