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Is it really necessary to start your home loan journey with a clean slate? Many first home buyers ask us whether they should be focusing on paying down debt, or building their house deposit?
Understanding your own personal situation goes a long way to answering this question.
- Are you managing with your current debt levels?
- Could you comfortably afford the repayments on the debts as well as a new mortgage?
If the answer is no, it might be best to focus on debt reduction before working on your deposit.
The case for paying off debt
The process of paying off high interest debt before you get a home loan may also positively impact your money management skills.
There’s no doubt the transition to homeownership would be much easier without any other debts hanging around. And now might be the best time to clear those debts once and for all. You could find it harder to get rid of debt once you have a mortgage repayment and other costs associated with property ownership.
We have you covered on all stages of your property journey
The process of paying off high interest debt before you get a home loan may also positively impact your money management skills, which will be helpful once you have a mortgage. And once you’ve made a dent in those pesky debts, you’ll supercharge your savings with the money that previously went to monthly repayments (and all that interest).
Here are three simple reasons why it’s a good idea to pay down debt:
- Improve your borrowing power
- Save on interest
- Stronger home loan application
Pay off your debts by:
- Choosing your highest-interest debt
- Directing all available money to this debt until it’s repaid
Not all debts are created equal
There are all kinds of debt – credit cards, car loans, HECS, interest-free plans and much more. But not all debts are created equal. Unsecured (and usually high interest) debt can limit your ability to save and affect your borrowing power. So, it’s a good idea to clear these types of loans before focusing on your deposit.
A credit card carries a high-interest rate and could take years to pay off if you’re paying the minimum each month. You’ll incur plenty of interest along the way too. On the other hand, HECs debts are not charged interest (they are indexed in line with CPI), only require payments when your income reaches a certain level, and they have no expiry.
In this example, credit cards will have a more significant impact than a HECs debt on you being able to save or meet mortgage repayments.
- Useful reading: Warning: Unsecured debt can bite
Meeting your commitments
In addition to debt reduction, financial discipline helps to prove your creditworthiness to a potential lender. Through your credit report, they can view your applications for credit, defaults and repayment history. Having a clean credit report and making repayments on time will give your lender confidence that you will meet your home loan commitments.
High credit limits may affect your borrowing power, so consider reducing your limit or closing your account before applying for a home loan. A lender will always include the full commitment in home loan servicing calculations.
- Useful reading: Bad credit and how to clear it
Be the boss of your budget
If buying a house is a top priority – we can help you plan to reduce debt and save for a deposit. Speak to one of our Yellow Brick Road Mortgage Brokers today.