Short term debt is so easy to use. Zero interest, points and perks are often too tempting to pass up. However, there’s a shadow side to short term debt that isn’t always recognised when you’re test driving a shiny new car. Depending on your income levels and how much lending you’re applying for, short term debt can stop you from getting approved for the home loan you need.
So how does your credit card or car loan impact your borrowing power? Read on to see exactly how lenders view different types of short-term debt and how you can improve your chances of getting approved for a home purchase.
Credit card and store card debt
Credit card and store cards are often misunderstood. Many people justify using them due to interest free periods or because they pay the balance each month. While this might bring some perceived benefits from a lending point of view, credit card limits show the bank how much debt you have the potential to get into.
For example, if you have a card with a $20k limit, in the banks eyes you effectively have $20k of debt, even if your balance is zero. Remember, the bank is assessing risk and they have to consider that you could easily rack up debt up to the limit at any time.
If you have large amounts of short-term debt and/or your income isn’t high enough to service the home loan you’re applying for, you may need to reduce your credit card or store card limit.
In general, having a lower limit is wise, so you don’t get trapped in the cycle of debt where your money is constantly tied up in paying interest on items that depreciate in value.
Car loans and personal loans
Though it can be emotionally satisfying, when you take out a loan to buy a car or big ticket item, it’s likely that whatever you’re is going to go down in value. This means you are paying interest on a depreciating asset which isn’t a good financial practice in the bank’s eyes.
On top of that, every dollar that is used to pay on short-term debt is money that can’t be used to support bank lending, so this means the amount of lending that you can get will be less.
What should you do about car and personal loans?
01 Pay it off as quickly as possible.
Use one of the 03 strategies in the Debt Crusher PDF to pay off the loans in the way that suits your situation. In the free pdf download you’ll find out what the 03 strategies are, how to decide which one to use and the step-by-step instructions to do it.
No matter the strategy you use to pay off your short-term debt as fast as possible, you’ll need to decide on how much you can pay as an extra repayment.
Once you know what your extra repayment will be and how often you’ll pay it, stick to it until you’re debt-free.
02 Stop taking out new debt.
Using debt to buy items whether big or small tells the bank you don’t know how to handle your money, so eliminating short-term debt from your spending habits builds a strong financial foundation.
03 Save up then buy.
Teach yourself to save a little over time and then purchase the items you want guilt-free!
Steps to Deciding Your Extra Repayment
For many Kiwis student loans have paved the way to a prosperous career. Unfortunately, they can be paying them off decades after the excitement of the new career fades and often well into the second or third career, becoming a financial burden.
The good news is banks don’t view students loans the same as other short-term loans. They’re considered to be less financially risky behaviour, so they don’t have as much of a negative impact on your borrowing power.
However, they will still count against your serviceability since your student loan repayments take away from your income.
To better your chances of approval, pay down your student loans as fast as possible, especially if the balance is small or you’re not looking to apply for a mortgage right away. If you anticipate needing a mortgage soon, make sure you’re paying the minimum repayment consistently and on-time to show the bank you are responsible with your money.
Probably the worst type of facility when it comes time to talk to a bank about borrowing money is Afterpay or any lending like it. Banks are really tough with this type of loan and they take away quite a bit of your usable income to cover themselves.
While these seem like an innocent and helpful loan product, think of it this way. If you have a $1000 limit and you buy $1000 worth of clothes, you have to pay this back over 4 weeks. That’s $250pw. This is the same as $13,000 per year. This is what the banks have to take into consideration with this type of facility as a worst-case scenario.
If you have Afterpay loans or anything similar, use one of the 03 strategies to pay off the debt as fast as possible and eliminate their use from your life…for good!
Keep in mind this article is providing general information and not individual advice.
To get 03 strategies to pay down your short-term debt as fast as possible, download this free pdf now.