When you apply for a loan, your prospective lender will weigh up your likelihood of repaying what they’re lending to you. They’ll run checks on your creditworthiness and spending patterns to gauge your financial character and thereby determine whether you’re likely to manage your mortgage and repay them in full.
They’ll look at your borrowing and repayment history, checking credit cards, overdrafts, hire purchase agreements, car loans, personal loans, mortgages, and power, water, gas and phone bills. They argue that how you manage small debt will be indicative of how you will manage a large loan.
Your perceived creditworthiness can affect not only how much banks will lend but the interest rate they’ll offer.
Credit checks
A prospective lender will run a credit check on you and will come back with a score between zero and a thousand. A score below 500 and you’ll find it difficult to qualify for a home loan. 500 to 700 is considered an average risk, and any score over 700 will be well-regarded.
What affects credit ratings?
Several factors can affect your credit rating in New Zealand.
• Credit history: This includes all accounts, such as credit cards, personal loans, or mortgages. A long history of responsible credit use can be a positive for your credit rating.
• Outstanding debts: A lot of outstanding debts negatively affect your credit rating as it indicates a high level of financial obligations.
• Payment history: A check of whether you have made payments on time, which includes bills. Late or missed payments can hurt your credit rating.
• Credit utilisation: This is the amount of credit you are using compared to the amount of credit available to you. Using a high percentage of your available credit can have a negative impact on your credit rating.
• Frequent credit checks: Credit inquiries for loan applications can affect your credit rating. Each credit check is recorded on your credit report. Multiple credit checks in a short period may be interpreted as you seeking a lot of credit or experiencing financial difficulties.
• Address changes: A stable residential address record will help your credit score.
• Bankruptcy: Current or previous insolvency on your file is seen as a strong indication of credit risk.
Credit cards
When banks weigh up how you will service your mortgage, they will also consider the amount of debt you could potentially have, not just the amount of debt you currently have. In other words, credit cards affect your ability to borrow on a mortgage because banks will look at the fact you can take on more debt. They then will work on the assumption that you will rack up as much debt as your card will allow you to. Therefore, the lower your credit card limit, the more you can borrow.
Credit card limits
To a lender, credit cards are a liability because they have to consider that you could draw down on the full amount at any point. You, on the other hand, may view a higher limit on your credit card as a handy ‘just in case’. So beware, having that extra money available could end up costing you dearly when it comes to applying for a home loan.
If you have the deposit for a property but are struggling to borrow enough, your credit card limit could be the deciding factor in mortgage approval. Reducing your limit from $20,000 to $5,000 could mean being able to borrow an additional $65,000.
Why? Because banks look at future potential credit card debt when calculating serviceability. If you borrow on your credit card, under the bank’s calculations there will be even less income available to go towards your mortgage. If you were to get behind on debt, you would be more likely to focus on paying off credit card debt because of its higher interest rates and thereby putting your home loan repayments at risk.
A survey of various banks by mortgage brokers and reported in the New Zealand Herald found that a couple earning $130,000 a year and with a $100,000 deposit could find the amount they could borrow reduced by $47,000 simply because they had a $10,000 credit limit on their credit cards. A $15,000 limit could drop how much they were able to borrow by $80,000 while a $20,000 limit could mean $100,000 less.
Just to paint a clearer picture, banks see 3-5% of your credit limit as a monthly expense. Roughly speaking, the minimum repayments per month on a $10,000 credit card limit is around $300 of income. $300.00 of income per month could cover around $45,000 of mortgage. In the bank’s eyes, therefore, a credit card limit stops you from borrowing and successfully servicing that amount of money. So, if you’ve got a $20,000 credit card limit, that could reduce your borrowing by just under $100,000, even if you don’t use it.
The card limit is the issue, not your balance or your spending patterns.
What to do about credit card limits?
If you are facing an income hurdle and are struggling to get the mortgage you want because of your income, then reducing your credit card limit or cancelling it completely can really help. Simply call your credit card provider and ask them to lower your card limits or close the account. That plastic card could reduce your mortgage borrowing potential enormously.
What to do about credit ratings?
There are many determinants of a credit score, and some have a stronger influence than others. Each impact on your score decreases with time, thereby lending more weight to more recent events.
It’s important to manage your credit responsibly and pay your bills on time. Late, missed or non-payments, including court fines, have a strong negative effect.
Paying off credit card debt as quickly as possible will help keep your credit rating in good shape. One option is to take out a debt consolidation loan with a lower interest rate than your credit card. You could save on interest and possibly pay off the total debt faster.
It’s always a good idea to be mindful of the number of credit checks you have done. Checks related to loan applications or car financing, for example, can negatively impact your credit rating. However, not all credit checks are the same. New Zealand has two types of credit checks: “hard” and “soft.” Hard credit checks are more comprehensive and are typically performed when you apply for credit. Soft credit checks, on the other hand, are less comprehensive and are for things like credit card offers or done by landlords and property management companies as part of the tenant screening process. Although they do not have as much of an impact on your credit rating, they are still recorded on your credit report. If you have a lot of soft credit checks in a short period, it may still be perceived as a red flag to some lenders.
Any defaults loaded with an institution on your credit check can be the deciding factor for the banks to so no to the lending you seek while you may be successfully meeting all the other lending criteria’s.
Applying for a home loan
If you have a poor credit rating, you may need to work on improving it before you will successfully get a home loan from a mainstream lender. As accredited financial advisors, our team at Global Finance can guide you so you can maximise your chances of a getting mortgage and we can present and argue your case for you. Talk to us and you’ll know what to do and what will work in your best interest.
The information and articles published on this website are true and accurate to the best of the Global Finance Services Ltd knowledge. The information given in articles on this website should not be substituted for financial advice. Financial advice should always be sought. No person or persons who rely directly or indirectly upon information contained in this article may hold Global Financial Services Ltd or their employees liable.