Why debt really matters for a mortgage

Prove you can stay on top of what you owe

Show you’ve a healthy relationship with credit cards and loans if you want to apply for a mortgage.

How would you describe the way you deal with debt? Perhaps you’re a steady Eddie who’s never missed a payment. Maybe you’re as regular as clockwork but prefer to only pay the minimum. Or, having fallen behind in the past, you don’t like to take on too much today.

However you handle cards, loans or other credit, you’ll need to convince a lender you’ve got a good relationship with debt if you want to apply for a mortgage.

What you owe, why you took it out and how you look after it is key. Any lender you approach will want to be sure you can look after a debt the size of a mortgage, as well as all your other repayments.

Here are five need-to-knows to help you prepare for an application.

Add up what you owe to avoid surprises

Perhaps you use a couple of credit cards for all your online shopping, and dip into your overdraft once a month? Or maybe you pay for a car loan monthly, and keep store cards for special offers.

Whatever your choice of credit, it’s part and parcel of being able to look after your personal finances – and any lender you approach for a mortgage will assume you have these kinds of debt already.

But while you wouldn’t be expected to have a perfect credit history or be completely debt-free, lenders will want to know how much you owe overall. Why? To be confident you can take on a mortgage on top of your existing debt without getting into difficulty.

To help it check if you’ll be fine, a lender will work out how much of your monthly pay goes on repaying debt – and decide if it’s too much or not.

For example, imagine your monthly income before tax is £3,000. You pay £200 towards a car loan and £100 on your credit card. With hopes for £700-a-month mortgage, this would take your monthly debt to £1,000.

Your lender then divides the two for a figure – £1,000 debt against £3,000 income would give 33%.

Although it’s a general calculation, you might hear it called a ‘debt-to-income ratio’ (its industry name).

As a rule of thumb, the lower your figure the better – and 33% would be a strong score. It suggests your personal finances are in decent shape to take on a mortgage, and you’ll likely get a competitive interest rate.

There’s no magic number to aim for, however. If a lender’s calculation gives you a high number but it thinks you’ll probably still be a good customer, it might then give extra scrutiny to your credit history or ask if you could focus on paying down any expensive debts.

How you handle your debt can be decisive too

Whatever cards or loans you already have, the manner in which you look after them is critical. Show you’ve a steady hand, repay on time and keep your spending under control, and it’ll go a long way towards proving you’re a good bet.

Say you have a trio of credit cards for good reason – one for cashback, another to rack up loyalty points and a third for overseas travel. Spend lightly on all three with regular repayments, and you’ll unlikely be marked down.

But it’d be a different story if you had a trio of cards you used only for spending, with credit balances constantly close to or pushing at their limit. A lender may well think this habit points to future difficulties.

For a clue as to how a lender might consider you as a mortgage candidate, check to see how much credit you’ve been given access to and what you actually use. Compare the two as a percentage – the lower the figure, the better. If your credit cards have a maximum spend of £5,000 and you currently owe £1,500, this puts you at 30%. As a guide, a borrower with a healthy credit score would typically sport a figure of 25%, according to credit agency Experian.

Show you’re on track if you’ve previously struggled

It’s not just debt size that can make a difference – so too could the kind of credit you’ve got, and why. Carry too much of what’s called ‘risky credit’, and it could count against you.

Say you’ve taken out a personal loan to buy a car for your commute and have steadily kept up repayments for a year. With a clear purpose and reason for your purchase using credit, it probably won't bother a lender’s review of your personal finances.

Compare this to a payday loan needed to tide you over for bills ‘til the end of the month. If you’ve one in your recent credit history, this type of debt often signals a red flag. It could strongly suggest you won’t be able to afford the mortgage you want.

If you do have a mix of good credit and risky credit, it’ll help if you can explain why. Often you may well have a very good reason for needing an emergency loan - you or your partner might have fallen seriously ill, for example, and couldn’t work for months. In such cases, as long as you can give a clear reason and show you’re back on track, you should still stand in good stead.

Steer clear of new credit (and think about cutting up old cards too)

Apply for new credit and you’ll find companies you’ve asked for money run what’s called a ‘hard credit check’. It scours your credit history for clues about your money habits and behaviour. However, asking for a new card or loan is also a clear sign that you need to borrow. Do this when you’re also about to apply for a mortgage, and it could indicate you may not be able to afford future payments – especially if you try two or three different lenders. Aim for a gap of at least six months to show you can meet your repayments before you apply.

You could also boost your appeal by closing old credit or store card accounts you no longer use. It shows you’re in charge of your spending, and can reassure lenders you won’t suddenly crank up your future spending. Choose your account closures carefully, though. A long-standing, stable financial relationship can mean a lot to a potential lender, so it could be worth keeping one open even if you rarely use it.

Tips to help pay down debt faster

If you think you’ve too much debt before you apply for a mortgage, try these steps to improve your situation. Don’t worry if it’s not easy to whittle down in a short time – your application will often still be considered if you can show a plan to reduce your debt in the near future.

  • Pay off more than the minimum

Add anything over the regular minimum payment to clear your debt faster and save you money in the long run.

  • Clear costly card debt first

If you have more than one credit card, be sure to pay down the one with priciest debt first. And if possible, see if you can switch outstanding debts to a 0% credit card (though watch for penalties). You can then try to clear what you owe without extra interest charges.

  • Use your savings

It’s often tough to use savings to pay off your debt, but it can be an effective way to reduce what you owe. This is because – in most circumstances - the debt cost is usually much higher than savings interest.  Say you’re earning 1% interest on savings of £1,000. At the same time, you’re paying 18% interest on a £1,000 credit card. Pay off the card in full and you’re immediately £170 better off.

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