When assessing your home loan application, a lender will take into account many of the debts you already owe. But what types of debt affect your borrowing capacity and your ability to get a mortgage?
How debt impacts on your home loan application
Most of us have some debt – from a student loan or tax debt to credit cards, personal loans, car loans, or an existing home loan. And any debt or credit cards you have when you apply for a home loan will impact on your application in two main ways.
First, a lender will factor in your need to service this debt when assessing your borrowing capacity, or your ability to service a new loan. Second, your repayment history on your existing debts, as well as the number of times you’ve applied for credit, will affect your credit score.
Lenders use your credit score as a guide for how responsible you are with money and whether you qualify for a home loan in the first place.
How your existing mortgage or home loan will impact on your application
If you have an existing home loan, one of the first things any lender will want to know is whether you intend to keep that loan or discharge it. If your plan is to discharge the loan, the lender won’t factor in the cost of those repayments when assessing you for a new loan.
But if you intend to keep your existing loan – say, you’re buying an investment property or holiday home, or even want to buy a new home but keep your current residence and rent it out – they will factor your need to keep paying the loan into your borrowing capacity. This could have a major impact on your application.
A lender will also take into account your ability to service any loans over investment properties you already own. If your loan has a variable interest rate, they will even factor in meeting these repayments at a slightly higher interest rate, to account for any future interest rate rises.
The flipside of this, of course, is that they’ll also consider any income you receive from investment properties, which may help your loan application rather than hinder it.
How your car loan affects your application
If you owe money on a motor vehicle, a lender will also factor in your need to keep making repayments. If you’ve taken out that loan with another person, such as your spouse, a lender may even treat the debt as though it’s entirely yours and reduce your borrowing capacity accordingly.
Alternatively, if you have a novated lease over your vehicle, that lease will come out of your pre-tax income and reduce the amount of money in your pocket each month. This could affect the income side of the equation and also reduce your borrowing capacity.
Why credit cards can have a major impact on your home loan
Of all the types of debt that will affect a loan application, it is probably credit card debt that is least understood.
When it comes to credit cards, a lender is less interested in how much you owe than how much you could potentially owe if you used all the money available to you.
In other words, they’re generally more interested in your credit limits than in your credit card balance.
For that reason, if you have multiple credit cards you could consider closing some down before you apply for a home loan or even consolidating your debts into your new home loan. You could also consider reducing the credit limit on any cards you keep so that they more accurately reflect what you need each month.
Read more about how reducing your credit limit can help your home loan application.
Personal loans and credit application
A bank or other lender will also consider any repayments you need to make on personal loans – whether secured or unsecured. If any of your personal loans come with a variable interest rate, they may also factor in a buffer on your repayments just as they would with any home loan.
For this reason, it’s a good idea to pay off as much as you can on any personal loans before you apply for a home loan.
Have you considered any student debt?
If you have any outstanding student debt like HECS debt, this too may affect your loan application. That’s because, even though your loan repayments don’t come out of your spending money, they will impact on the amount of money coming into your account each month.
Generally, you’ll need to start repaying any HECS debt once your income reaches a certain threshold – currently $51,957 a year. And, depending on what you earn, the amount you need to repay could be substantial.
For instance, if you earn over the top threshold of $107,214, you need to repay your HECS debt at the rate of eight per cent of your income per annum.
When you apply for a home loan, a lender will always look at both your income and your ability to service a loan, as well as your credit score.
As any other loans could affect all three, you should do what you can to pay these off and reduce your credit limits where possible, before you apply.