You are thinking of buying your first home which is super exciting! You probably already have a TradeMe watch-list that you look at daily. You may already be scanning the mailers, circling possible properties, and scheduling those open homes in your calendar. But ... you have existing debt and you're not sure if this is going to affect your chance of getting the keys to your very first home. The good news is we are here to help clarify those scary thoughts around debt.
Typical sorts of debt you may have
We would all like to live a debt-free life - but in reality, this is often not possible. The thing that you need to consider is whether your level of debt is deemed as acceptable by the bank, or if it's going to be a massive warning sign that may put a potential lender off your application. Here's our run-down of some of the most common forms of debt.
- Student loan - Many first home buyers have student loans that they're still paying off. The good news is that this is rarely going to stop a bank from lending to you. If you're making regular payments and chipping away at it, then the loan itself is unlikely to matter much.
- Car loan - Often a vehicle is needed for everyday life. If you have finance on a car then this may not preclude you from getting your first mortgage. If you're able to keep on top of payments and still cover your rent as well as add to your savings then you may be fine.
- High interest credit cards / store cards - Store cards in particular often come with high interest rates - be wary and focus on paying them off before it gets out of hand. Banks will often consider the full amount you could spend on a credit card (even if you haven't) when assessing whether you can afford to pay a mortgage.
- Personal loans - Again personal loans are often higher in interest. Be considerate of what you are taking out a personal loan for - is it for a necessary cost or discretionary purchases? It's often sensible to try to make additional payments on these to have them cleared off as soon as possible.
- Pay day loans - These can be the worst type of short term debt, with astronomical interest rates ! Anything that has a high interest rate needs to be a priority to pay off as the interest cost alone can cripple you financially in the future.
If you have any, or all of the above then you shouldn't worry. Many home loan applicants have debts, but you should try to rid yourself of as many of the above as possible. Sorted.org offers an array of fantastic tools and guides; from planning and budgeting, to how to tackle debt. You can also see a local financial advisor to help you understand how to better manage your financial situation and assist in making your goals become a reality.
Applying for a home loan with EXISTING debt
The great news is that you can buy a house when you have existing debt - it all comes down to affordability and your debt to income ratio. A debt to income ratio determines what percentage of your gross monthly incomes goes towards paying off debt. Here's how it is done:
- Calculate all your monthly debt payments – including credit cards, car finance, student loan, etc (if you don't have fixed monthly payments, you can probably estimate your monthly payments at say 4% of the total amount you owe)
- Take your gross annual wages and divide them by 12 - that's your monthly income
- Take your total monthly debt payments and divide them by your monthly income
- Move the decimal point two digits to the right to make it a percentage - that's your debt/income ratio
For example, let's says you earn $48,000 gross per year, making your monthly gross income $4000 ($48,000 / 12). You have also worked out that your monthly debt repayment is $600 making your debt to income ratio 15% (600/4000 with the decimal moved two digits to the right).
There's no fixed percentage that guarantees you'll get a loan, as there are numerous other living costs to factor in. Generally the lower your debt to income ratio the better, especially when combined with regular savings and a sensible spending attitude. If it turns out that your current level of debt will likely be an obstacle, there are steps you can take to ensure that you are still working towards your goal of home ownership.
There are many things that need to be taken into account when buying your first home including income, regular outgoings, as well as debt, employment status, credit history and savings. Unfortunately those handy little home loan calculators, although great for a quick glance, do not look at the complete picture - it is best to talk through your options with a financial professional directly.
Our friendly advisors at Stephanie Murray Mortgages can help with exactly that. Our consults are absolutely FREE and require no commitment - together, we can make a plan for you ! Click here or on the image below to book a 'no obligation' chat.