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Debt isn’t a deal-breaker when you’re thinking about buying a home. But how you manage debt is one of the key things a lender will look at when you’re applying for a home loan.
How does debt affect a home loan application?
1. Credit score
A credit score is a number assigned to you that helps a lender decide if they will give you a loan. It’s based on criteria like the amount of money borrowed previously, how many credit applications you’ve made and whether you make your repayments on time.
- Useful reading: Bad credit and how to clear it
2. Borrowing power
Lenders calculate serviceability based on income available to meet all debt repayments, living expenses and the proposed home loan amount. For any type of revolving credit like credit cards and lines of credit (which are often provided as part of interest-free purchases), the lender will always use the credit limit available to you in their calculations rather than the outstanding balance. Reducing your credit limits or clearing your debts (and closing the account) will positively impact your borrowing power.
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Review your loans, bills, credit cards and expenses
Making a list of everything you owe is the first step to working out a plan for managing your repayments and reducing your debt. Draw up a budget itemising your income and expenses, including the minimum repayments required for all credit card and loan accounts. Prioritise them in order of importance and seek help from your providers if you’re falling behind.
Pay more than the minimum
Most minimum repayments barely make a dent in paying off debt. If it’s affordable to pay more than the minimum, consider snowballing your debts to clear them sooner. Snowballing is a process where you put extra money directly into one loan or credit card until it’s fully paid off while still meeting the minimum repayments on your other debts. Then you move onto the next one. This helps in two ways;
- As a loan is repaid, the money that was budgeted for its minimum repayment can now be put to use paying down another debt, and
- Knocking over debt will give you motivation to keep going.
You should always make sure your loan repayments and household bills are paid on time because late or missed payments will be tracked on your credit report. Repayment behaviours help a lender decide if you’re a good credit risk. Set up automatic payments in advance to make your repayments on time or set calendar reminders for any other regular and ongoing bills to ensure you don’t forget. There are several good budget management apps available as well to help you get a handle on your situation.
Earn extra cash
One of the best ways to smash debt is to throw extra money at it. If you receive a pay rise, tax refund or an unexpected windfall – send it straight to paying down debt. You won’t miss it. You could also find ways to earn extra money such as a second job, or selling items you don’t need anymore.
‘No spend’ challenges have become popular in recent years. Whether it’s weeks, months or years, these kinds of challenges help us be mindful of how we spend money. Let’s face it; we can all get a bit loose with our purse strings from time to time. Try shopping from your pantry to reduce your grocery bill or look at the back of your wardrobe for any forgotten favourites. It all helps.
- Useful reading: Plug your money leaks
Don’t fall back into bad habits
Revolving credit facilities can wreak havoc on a clean slate if you don’t change the behaviours that got you there in the first place. Have a chat to a Yellow Brick Road mortgage broker to get a firm grip on your finances and find your way into your new home.