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How your debt impacts your borrowing power

Many Australians go into the property buying process with existing debt, and this doesn’t always impact on their ability to get approved for home loans. If you want to buy a home, it’s important to understand how your debt will impact on your borrowing power and approval likelihood.

Here we’ll explain what borrowing power is, as well as how student debt, personal loans, car loans, credit cards and existing mortgages can impact your borrowing capacity.

What is borrowing power?

Borrowing power is a term lenders use to describe the loan size that they are likely to approve you for, based on your financial situation. If you have a high borrowing power, it means that lenders trust you to repay a larger home loan.

Factors that can increase your borrowing power include:

  • High income, in relation to how much you want to borrow
  • Stable job
  • Low debt
  • Large deposit
  • Assets
  • Reasonable living expenses

Your borrowing power will likely be weak if you have a lot of debt, a bad credit history, a low deposit and poor financial management. Read about how to increase your borrowing power here.

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How student debt impacts your borrowing power

It’s very common for first home buyers to have student debt, and it generally won’t be a significant barrier towards getting a home loan. However, it can impact your borrowing power.

Having a high debt to income level can make you a less serviceable borrower, but every bank calculates serviceability differently. How your university debt is viewed will vary between lenders, and also depend on other factors such as:

  • The amount of debt
  • Your income
  • Your profession
  • Any other debts

How is HECS repaid?

Because of how university debt is structured and repaid in Australia, some lenders treat it differently to other common debts (e.g. car loans and credit cards). You start to repay HECS-HELP debt once you hit a certain income threshold and it will be automatically deducted from your wage. Unlike most other debts, interest is not charged on HECS-HELP, but it is subject to indexation.

Can I still get a home loan if I have a HECS debt?

Some lenders will treat HECS debt just like regular debt, but that doesn’t mean you won’t be able to get a home loan. This debt will simply become another consideration for your lender in calculating your borrowing power.

To improve your borrowing power you can:

  1. Pay down your HECS-HELP debt. Note that this will delay you getting into the property market.
  2. Increase your income through seeking a pay rise or getting an additional job.

If the rest of your home loan application is strong (i.e. solid income, minimal unsecured debt, stable job, healthy credit rating), a reasonable university debt shouldn’t be a major issue. For example, it’s likely that a young dentist will have HECS-HELP debt, but they are also likely to have a high and stable income that will be viewed favourably.

Want to check your HECS-HELP debt? Head to the myGov website. Here you can also make voluntary payments towards paying off the debt.

How personal loans impact your borrowing power

Personal loans can reduce your borrowing power as they are another expense that reduces how much you would reasonably be able to repay on a home loan each month. Personal loans usually attract higher interest rates, so they can take longer to repay than you might expect.

To reduce the impact of higher interest rates on unsecured debts like personal loans and car loans, you could consider debt consolidation.

One thing you can do to increase your borrowing power if you have personal loan debt is switching to a fixed rate for your personal loan. Lenders typically add a buffer of about 1.5% on top of variable interest rates to account for possible rises in the future. When they do this, your borrowing power decreases. Otherwise, focusing on paying down the debt is a smart option.

How much can you save by consolidating debt?

Roll your credit card, car or personal loans into your home loan.

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How credit cards impact your borrowing power

Remember that even if you repay your credit cards each month, some lenders will still view your credit card as a potential debt. So, if you have a credit card limit of $3,000 per month, a lender might see that as $3,000 of potential debt for every month.

Even if they don’t view them as a potential debt, they will likely assume that you’re reaching the full limit every month because there is a possibility that you will in the future. This is something lenders need to account for when assessing an applicant’s borrowing capacity.

If you don’t have a need for your credit cards, it might be wise to cancel them in the lead up to your home loan application process. If you still want to keep a credit card, consider reducing the limit to improve your borrowing power.

Having unpaid credit card debt will likely reduce your borrowing power, and it may be something to target before you apply for a mortgage.

How car loans impact your borrowing power

Car loans are often viewed similarly to personal loans. Both typically attract higher interest rates, due to usually being unsecured debts, and can limit your borrowing power. It might be a good idea to work on paying off your car loan debt. This will demonstrate to lenders your ability to make loan repayments and may strengthen your credit score.

Opting for a fixed rate car loan can increase your borrowing power as lenders won’t apply the buffer to protect themselves against future rises in interest rates.

Existing home loan debt

If you already own a home, this can be beneficial - even if you still have a mortgage to pay off. Depending on your loan to value ratio (LVR), you may be able to use your equity to provide a larger deposit for your next property purchase. This will increase your borrowing power and if you are receiving any rental income from investment properties, this will also help boost your application.

How much equity can you access?

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Having existing debt when you want to purchase property isn’t necessarily a major obstacle. There are always ways to improve your borrowing power and if you’re having trouble, it may be worthwhile to speak to a mortgage broker. Lendi’s Home Loan Specialists are on hand to provide free expert advice, so get in touch today.

Got a home loan question? Just ask!

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The information in this post is general in nature and should not be considered personal or financial advice. You should always seek professional advice or assistance before making any financial decisions.

Tags: interest rate, new purchase, home loan, refinance, lender, equity, debt consolidation, debt service ratio, debt to income ratio, credit score, bad credit

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