While you don’t need to be debt-free to secure a mortgage, you do need to demonstrate that you’re responsible with your finances. This means steadily paying down existing debt and saving regularly.
Here are seven steps you can take to reduce your debt and ensure you’re home loan ready:
Work out how much you spend
First things first, you need to know where your money goes each month. A good way to do this is download a spending and budgeting app. While there’s some initial effort involved to set up – categorising expenses, setting budgets and linking accounts – it’s worth it for the insight and control you gain. Popular free options include PocketBook, Mint and TrackMySPEND. Many of the banks also offer their own apps.
Decide where to cut back
With a visual representation of your spending, it should become clear where you can save money immediately. Remember: small changes can make a big difference over time. For example, that second cup of coffee a day could be costing you $20 a week – about $1,000 a year. Lunch each day could be adding up to $60 a week – about $3,000 a year. One less bottle of wine a week could save you another $1,000 a year. With small lifestyle tweaks, you can free up more money to pay off debt faster.
Check your outgoings
It’s worth examining your bills: can you get a better deal on interest rates/banking fees/insurance premiums/utilities/ internet services by changing providers? Are you paying for memberships or subscriptions you don’t use? Similarly, do you have the right financial products for your needs, or are you paying for features you never use? Shopping around for the best deal can free up cash flow, which could be put towards your debt or savings.
Pay off your credit cards
It’s easy to spend more than you can afford on a credit card and find yourself in financial difficulties. As you pay a daily interest charge on any unpaid amount each statement cycle, you pay interest on top of interest and can rack up sizeable debt quickly – particularly if you continue to spend on the card. It’s therefore essential to rein in discretionary spending and pay off high-interest credit card debt as soon as possible. Lenders will look closely at how you manage your credit cards when assessing your home loan application.
Make payments on time
Be aware that your repayment history is captured in your credit file for each line of credit you have. This includes your contracts for services such as utilities and telecommunications. If you miss payments, this information will be recorded in your file and could lower your credit score. It’s extremely important to demonstrate your credit worthiness by having a clean credit history.
Improve your credit score
Your credit score is calculated on the amount of credit you have available, the type of credit you have, and how reliable you are at repaying it. So, as well as paying your bills on time, you can improve your score by:
- cutting spending so you can lower your credit card limits
- closing any accounts you don’t need
- not borrowing from ‘risky’ lenders (i.e. payday loans)
- not applying for new lines of credit in the six months prior to a home loan application
- disputing any errors on your credit file (i.e. incorrect credit limits or mistakes in your repayment history).
Ramp up your savings
While paying down your debt, you’ll also want to start ramping up your savings. A 20 per cent deposit is ideal to avoid having to pay lenders’ mortgage insurance and to lessen the amount of interest you pay over the life of the loan. Most lenders like to see that your deposit comes from ‘genuine savings’, which demonstrates financial responsibility. That’s why it’s a good idea to set ambitious savings targets.
The stronger your financial position, the more likely you are to be approved for a home loan at an attractive interest rate. And that can make a big difference to your financial future.
About the Author
Since 2008, David Thomas has built a business aimed at servicing the needs of property investors, owner occupiers and small business owners. David is recognised as one of the top 10 independent mortgage brokerages in the country, David and his team have settled almost billions of dollars worth of residential and investment loans over the last decade.
Known for his straightforward, relatable style, David believes by educating people about property funding; they fare better in the market. By sharing his expertise openly, some of the people he educates will likely become his clients. It's a win-win approach.
David Thomas is a credit representative (Representative Number 506153) of BLSSA Pty Ltd, ACN 117 651 760 (Australian Credit Licence 391237).