When applying for a home loan, part of the assessment process includes what is generally called a “serviceability assessment”. In other words, it’s a way of testing how much you can afford based on your income and minus expenses.
Part of the expense category will include debts (also known as liabilities). Not all debts are equal and when it comes to buying a house, some debts can be helpful and some not so much!
Most lender serviceability assessments require a positive net income position (also known as surplus income) and many lenders also have DTI (debt to income) benchmarks which need to be met.
Below is a summary of some common types of debt you will need to declare to your Mortgage Broker and how they might affect your home loan borrowing capacity.
Credit Cards and Store Cards
This includes all types of credit cards from bank issued to interest free store issued cards. While credit cards can be useful, particularly when overseas and/or buying online… it’s important to understand that lenders will want to include these as debts.
Furthermore, regardless of your credit card balance the lenders will generally assess your borrowing capacity using the accounts full lending limit. For example, if you have a credit card with a balance of zero but a limit of $15,000, the full limit of $15,000 will be factored into the assessment and in turn can lower your overall borrowing capacity.
Often it may be beneficial to close any unused credit cards either prior to or as part of the application process when applying for a home loan as it can be an easy way of improving your borrowing capacity.
Personal Loans and Car Loans
Personal loan debts of any purpose will need to be declared and ultimately can impact your borrowing capacity. Information needed in order to accurately assess the debt include the balance owing, repayment amount and interest rate as these determine how the debt will be entered in the serviceability assessment.
Loan agreements with family or friends are often treated like Personal Loans obtained through a financial institution and as such, can impact your ability to secure a home loan.
There can be occasions where using part of your savings to clear and close a personal loan debt may result in your borrowing capacity improving. It’s important to speak with your Mortgage Broker in advance though as using savings that were originally set aside for the purpose of buying a home, can hinder or delay your plans with applying for finance.
Most vehicle leases tend to include all vehicle related expenses and be salary sacrificed to include both a pre-tax and post-tax deductions which are shown on payslips. Each lender has their own way of calculating vehicle leases, particularly given that Motor Vehicle expenses is its own category within your declared general living expenses.
While vehicle leases do have their advantages, it’s important to keep it in mind that they can impact your borrowing capacity differently to a car loan.
Buy Now, Pay Later
Afterpay and zipPay are two of the more commonly known “buy now, pay later” options currently available. It’s important to know that while these facilities may feel similar to the traditional LayBy offered by retailers, the repayment responsibility falls on you and as such, if you fail to keep up with instalments or to pay by the scheduled date, you may have to pay interest, fees, or the debt may adversely impact your credit file.
Lenders will not only treat these facilities as debts therefore reducing the income you have available to secure a home loan, but the way the liability is treated now means it can also impact your overall Debt to Income ratio.
Often it may be beneficial to close these facilities either prior to or as part of the application process when applying for a home loan as it can be an easy way of improving your borrowing capacity.
HECs – Student Debt
Your income versus your expenses forms a big part of the home loan application assessment. Unlike the majority of debts, student debt is assessed as an ongoing repayment based on your income. If your annual income meets the income threshold, then repayments of student debt is required. The repayment rates start at 1% of your income and increase as you earn more, up to a maximum of 10% of your income. Repayment of student debts can impact the income you have available to secure a home loan and the amount you have owing on your student loan can impact your Debt to Income ratio.
While these debts can be paid off in advance, often there may be other debts held which can be paid off first and could achieve a similar or better result when assessing your borrowing capacity. Speaking with your Mortgage Broker early will be beneficial in this instance as they can help you to determine which debts (if applicable) should be focused on clearing first.
If you are a self-employed business owner, you will be required to declare all debts and that includes debts held within your business. Lenders will assess business related debts differently and it’s important to speak with your Mortgage Broker to understand how this may impact you.
If you have taken out a loan with someone else, it’s likely you are a co-borrower. While the debt is jointly owned, many lenders will treat you individually liable for the debt. This means that if the other person was unable to repay the loan, you’re then fully responsible for the debt. If the home loan you are seeking does not involve the same person as your existing joint loan, then that debt may be considered 100% your loan and therefore can significantly affect your borrowing capacity.
The way this type of debt is assessed by lenders can vary, as not all will treat the loan this way if specific criteria can be met. Some lenders offer what is commonly called a “common debt reducer” where they essentially only include your percentage ownership of the debt when assessing your borrowing capacity.
Becoming a guarantor can have its advantages, particularly if you are a parent assisting your children with purchasing their first home by being a guarantor. It’s important you seek professional advice before entering these agreements to understand your legal risks with being a guarantor.
Additionally, if you apply for a home loan yourself in the future, you’ll have to disclose you’re a guarantor which may have adverse impacts on your borrowing capacity restricting your ability to secure a home loan. Planning is important to prevent possible delays with your own home buying plans.
In summary, managing your debts efficiently can be the difference in achieving the borrowing capacity you require to purchase your dream home. Engaging with a Seek Financial Mortgage Broker early can help you to better understand which debts are hindering you the most and to set goals so that you have a clear path moving forward towards success.
The above information is general in nature. It has been prepared without taking into account your objectives, financial situation or needs.