Foreign Currency Contractor Mortgages

Are there any risks with taking out a foreign currency contractor mortgage?

Foreign currency contractor mortgages are not without risk. Because getting a mortgage to buy a property is such a major life event, it's important to be fully aware of the potential downside before you apply.

The dangers of currency fluctuations

With foreign currency earnings, it's understandable to be concerned about the potential for volatile currency fluctuations to negatively affect your income when converted back into sterling.

Here's an example. Contracting as an IT analyst, Tom earns $12000 a month, working remotely from the UK for a US-based software company. He has a fixed-term 12 month contract.

When he takes out the mortgage, the exchange rate is 1.20 USD to 1 GBP, giving him a monthly income of £10000 per month. Comfortably enough to afford the mortgage payments.

Fast forward a year, and the pound has strengthened considerably. Now a pound buys $1.5 US dollars.

Or to put it another way, whereas before each dollar would convert into £0.83, now each dollar only generates £0.67.

Which means, Tom's income when converted into sterling would decrease by 20 per cent to £8000 a month. Still a very healthy salary, but if the pound kept strenghtening, it could potentially make his mortgage unaffordable, depending upon his other outgoings.

Of course, the opposite could happen, and Tom could benefit from sterling weakness. Nevertheless, the variance in income makes some lenders cautious.

How lenders mitigate the risk of adverse currency movements

In assessing an applicant's foreign currency income, lenders mitigate against potential adverse currency fluctuations by applying one or more restrictions, such as:

• Using the lowest exchange rate for the last two or five years
• Using the lower of the exchange rate over the last 5 years OR the exchange rate on the day of application, less 20%.
• Requiring a guaranteed minimum sterling equivalent income written into the contract
• Deducting 20% (sometimes more) of the applicant's GBP income, once converted from the foreign currency.
• Reducing the maximum Loan-to-Value (LTV) available

Some mortgage companies combine one or more of the above and use the worst case.

For example, they might use the lowest exchange rate over the past two years, or the exchange rate on the date of application minus 20%, whichever is lower.

Luckily, not every lender applies a 'haircut'. Some simply apply the spot forex rate on the date of application. The currency exchange website xe.com is widely used for conversion.

Warning borrowers of negative currency movements

Every mortgage provider is required by the FCA to monitor currency fluctuations and warn the mortgagor (the person or persons taking out the mortgage) whenever the exchange rate of the overseas currency falls against the pound by 20% or more.

How much can I borrow?

How much you can borrow all depends on whether the lender treats you as self-employed or employed contractor for income verification.

Income assessment for day-rate contractors

It's common for workers with fixed-term or rolling contracts denominated in foreign currency to receive earnings into a limited company and pay their own tax.

Even though you're self-employed, in the right circumstances, contractors can be treated as employed for mortgage purposes. In such cases, the lender will base affordability and income assessment using your contract's day rate pay.

This can be hugely advantageous, as it often means you can borrow more than if you're assessed as a self-employed company director.

In the latter scenario, your share of your UK limited company net profit and salary (or dividends and salary) is calculated to produce a maximum borrowing figure.

Many providers will average the last two financial years or the latest year's figures if it's lower than the previous year.

How lender's determine if they'll use your day-rate

Whether you are classed as employed or self-employed is lender dependent. Each uses different criteria. For example:

• A minimum income level of £50,000 - £75000 p.a. Employed
• More than one contract running simultaneously. Often self-employed but some providers can treat as employed.
• Employ other contractors - Self-employed
• More than six weeks gap between contracts in the last year. Self-employed
• Pays their own tax - Self-employed.

Some of these criteria have exceptions and/or override one another. For example, one major lender will treat IT contractors on any income as employed even if they pay their own tax.

The only exception is if the IT contractor employs other contractors through a limited company.

Day rate income calculations using foreign income

Banks and building societies that accept foreign currency income will use your day rate and multiply it by either 220 or 230 days a year (46 or 48 weeks respectively), depending on the lender's criteria) to work out your income.

Of course, the income is prorated if the contract(s) stipulate fewer hours a week,

Next, the currency exchange is applied at the spot rate on the day of mortgage application, along with any 'haircuts' to produce the sterling-denominated annual income.

Finally, the provider applies their loan-to-income (LTI) multiple and makes any deductions for ongoing committed expenditure such as spousal support, credit card balances, car finance etc.

An example borrowing calculation

Let's assume our example contractor is paid $600 a day for 35 hours a week work, over 5 days. His USD earnings works out at $138,000 p.a (600 x 5 x 46).

On the application date, the USD to GBP exchange rate is 1.2 dollars to the pound, giving a sterling income of £115,000.

Now some lenders won't apply any 'haircut', allowing the contractor to potentially borrow up to £517,500. Some lenders may allow higher borrowing due to the high income.

But let's say the lender automatically deducts 20% to protect against variance in the Forex rate. Now the borrower's income is assessed as £92000, giving a maximum borrowing figure of only £414,000 based on 4.5 times income.

Other lenders will only work from your limited company accounts net profit and salary or, for sole traders, gross income before tax as shown in your SA302 / tax calculations.

Regardless of your self-employment status, some banks and building societies are happy to lend based on assessing just your latest year's income, rather than an average of the last two.

What documents do I need to show lenders?

The precise documents you'll need will depend on whether the lender considers you self-employed or employed for mortgage purposes. Our self-employed mortgage document checklist here has more details.

Getting a mortgage quote

As you can see, the eligibility criteria for contractor mortgages becomes increasingly complex when foreign currency earnings are involved.

As an independent, whole-of-market broker specialising in self-employed mortgages, SEMH will quickly source the right lender and mortgage product for your exact circumstances.

We'll save you hours of time and frustration, and potentially a lot of money as well. To get started, schedule an initial enquiry call with an advisor now.

The call should take no more than 15 minutes, you can book a slot at a time and date to suit you, and there's no-obligation.