How debt impacts your home loan application
Almost everyone has a debt of some sort - whether it be paying off a student loan (HECS or HELP debt), tax debt, credit cards, personal loans, car loans, or an existing home loan. These debts can affect your proposed home loan application not only impacting your borrowing capacity, but also what type of product you are offered by the bank, depending on your repayment history.
A lender will factor in your need to continue to service or meet this regular repayment obligation, in assessing your borrowing capacity or to determine your ability to service a new loan.
Further, your repayment history on your existing debts plus the number of times you've applied for credit will affect your credit score. Your credit score will be a guide for lenders to examine how responsible you are with money and to qualify for a home loan. If you have a lot of unsecured credit, then this can be interpreted by a bank as a potential that the client is living beyond their means, and care must be taken to ensure that this discussion is managed carefully. Often we will see clients having taken up a number of credit cards, to take advantage of Award point offers for travel redemption or the like, without understanding the potential implication to their Credit Score or borrowing capacity.
Whether secured or unsecured, a bank or lender will consider repayments you have to make on personal loans. Same with home loans, they may factor in a buffer on your monthly repayments to stress test the repayment, should the interest rate change.
Any outstanding debt like HECS debt may affect your loan application because it impacts the amount of money coming into your account each month.
If you happen to have one, you'll need to start repaying HECS debt once your income reaches a certain threshold that's currently $45,881 a year, and the repayment is based on a percentage of your earnings, depending on what your annual gross earnings are. You can find out more about HECS debt repayment obligations here.
Existing mortgage or home loan
The first thing a lender will want to know is whether you plan on keeping that existing loan or discharging it. If you plan to discharge the loan, the lender will not factor in the cost of those repayments each month in assessing you for your proposed new loan.
If you plan on keeping your existing loan, the bank will factor your need to keep paying the loan into your calculated borrowing capacity - this may or may not impact your application. The lender will also include your ability to service any loans over your investment properties (and include a proportion of the rental income you receive, as well as some tax benefits).
A lender will factor in your car loan repayments. Even if you took out that loan with another person, a lender may treat the debt as it's entirely yours thus reducing your borrowing capacity, or they may split the loan proportionately, depending on that specific bank’s policy around the same.
If you have a novated lease over your vehicle, it will likely come out of your pre-tax and possibly also your post-tax income and reduce the amount of money in your pocket each month. This would also need to be considered as an ongoing liability.
As a general rule, if you have a car loan of $30,000, then it is likely that this monthly obligation will reduce your borrowing capacity for lending for residential purposes, by approximately $150,000. Careful discussion should be taken before applying for vehicle finance, and considered within the scope of what you are looking to achieve within property and property lending for the coming 5 years, given the potential implications. It is imperative you speak with a finance specialist to ensure that you are planning and mitigating any potential issues.
Credit cards have a major impact on your home loan
Lenders are less interested in how much you owe, and rather more focused on how much you can possibly owe! They're generally more interested in the credit limits than your credit card balance.
The best practice for this is to consolidate your debts or reduce multiple credit cards. Consider closing some cards down, reducing the credit limit of any cards you keep, or consolidate your debts into your new home loan.
It is notable that most banks will assume that your monthly repayment to a credit card, is between 3% and 4% of the limit of the card. If you have a credit card with a limit of $20,000 and the bank assumes a 3.5% repayment obligation if you were to max out that facility, then the monthly repayment could be around $700 per month. $700 per month, is equal to around $100,000 in residential finance borrowing capacity, so credit card limits can have a major impact on your borrowing capacity.
Building your Credit Score
Over the years, I have had so many discussions with clients, who think they should apply for a credit card, a personal loan, or a car loan, to build a credit score, but the complete opposite is true and this is an Urban Myth! For every application for unsecured credit or finance, your credit score is diminished, not improved. So, before you apply for credit to build a credit history, please speak with us. The truth is, you are far better off to put your effort into creating a savings history instead.
Last but not least…
A lender will always look at your income, your ability to service a loan, and your credit score.
Any other loans could affect all three. Before applying for a home loan, make sure you talk to us, so that we can support and guide you towards planning and achieving the outcomes you want and need!
Let's have a chat to discuss options on how we can help you save more!
Rachael Bland – Founder & CEO