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Applying for a loan? Don’t just pay off your debts

Applying for a home loan

It sounds basic, right? Just like the easy way out we often opt for, you buying a home, so you pay off your credit cards to reduce the debts, but you still keep them active, so you could buy some furniture or deal with emergencies even when you have a mortgage. Easy! But wrong.

Lenders would definitely consider your credit card debts as well as monthly repayments when you apply for a mortgage. What most people are ignorant equally about is, even credit cards which have no amounts owing, can also influence the lender’s assessment of your borrowing capacity.

Let’s consider you have a high credit limit, in the eyes of your lender you also have a high debt risk. It is simple logic; nothing would stop you from obtaining more debt on your credit card immediately the loan is approved. Like, on some lovely furniture to fill that new house.

According to the finance broker, we have to take account of three per cent of the total credit card limit no matter what the applicant owes.

For example “If they had a $10,000 limit but they only owe $1000, we still have to assess $300 a month and that comes directly out of their liability. It does make quite a difference”. Says the broker.

In this light, it can be summed up that if you haven’t put a cent on your credit card for the past five years, a high credit limit will negatively affect your serviceability; $300 per month off a mortgage repayment means quite a bit over the life of a loan. In fact, being able to repay an extra $300 each month on a 30-year $500,000 loan at 5.5 per cent interest will mean paying it off 5 years faster, and saving more or less $100,000 on the total cost of the loan. Instead, it may mean that you are able to borrow an extra $50,000.

Your best option is to cancel your credit account or better still lower your credit limit.

You ought to pay off your credit card and avoid having any other debt, plus you need to be able to use your full amount of income, says the finance broker.

For those who have to pay off their credit account before dreaming of cancelling their liability, it is, of course, imploring to make those payments on time to avoid negatively impacting your credit history.

The first step towards finding your new home is speaking to an MFAA Accredited Finance Broker to sort out the finances.


*This information is not to be relied upon without speaking to your finance broker, tax agent or financial adviser.

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