THE TOP 7 TIPS FOR WHAT TO DO WHEN YOU HAVE TOO MUCH SHORT TERM DEBT

Debt is one of the biggest roadblocks we encounter when trying to help people apply for mortgages. Short term debt like credit card debt, personal loans, car loans and hire purchase arrangements can severely impact your chances of getting a mortgage approval. 

Why Is Debt Such A Problem?

When the bank looks at providing a pre-approval, they are assessing your deposit and loan to value ratio, but also your income, general living expenses and current debts to determine your affordability. The affordability criteria for each bank differs slightly but generally is quite strict.

The Effect of Debt on Your Borrowing Power.

As a rough guide, $10,000 on a personal or bank loan will have the effect of reducing your borrowing amount by $53,000 (depending on what your current repayments are).  $10,000 of credit card debt has the effect of reducing potential borrowing by $46,000.

 

The Top 7 Tips to Reduce Your Debt


1. Create a budget that includes a weekly debt repayment

If you are serious about getting your mortgage approval, a budget should be an essential part of your plan.  A budget can be used to get a repayment plan on track and once you’re at zero debt, these payments can become contributions to your deposit.

Creating a budget may seem tedious, so luckily there are some great tools out there to help you.  Sorted.org has a great budgeting tool that allows your spending to be tracked.

The key part of budgeting is to include a weekly amount for debt repayment.  The payment should be manageable but also make headway into actually paying off your debt, not just keeping up with interest payments. Remember – be sure to set your repayments up as an automatic payment, so it is set and forget.

2. Prioritise the Debt with the Highest Interest Rate or Smallest Debt.

If you’ve got debts of various types (credit card, personal loan, hire purchase), a good way of getting them paid off is to prioritise them in order for focused repayments.  There are two suggested ways of doing this.  The first option is to prioritise the debt with the highest interest rate.  The benefit of this is to minimise the total interest cost by shortening the length of time it is accruing interest.  The second way is to focus on the smallest debt which helps to get the ball rolling on your debt repayment and encourages you as you tick one debt off the list.

3. Contribute Any Additional Cash to Debt Repayment.

From time to time we come into some unexpected money, be it a work bonus or a tax refund.  While the temptation is to spend it, try to keep your eye on the ultimate goal and use it to get rid of that debt quicker.

4. Make Efforts to Change Spending Behaviour.

Getting on top of your debt is really only going to truly work with a committed effort to change the behaviours that got you into debt.  Did you buy a new car on finance?  A better approach is to re-adjust your sights to a car you can afford to buy, from money saved.  Paying cash will also give you the opportunity to negotiate on price, as well as avoiding ongoing payments for an asset that is losing value.

If you’ve got credit cards that you struggle to avoid maxing out, you should cancel them to avoid your credit repayments being wasted. Of course, you’ll need to pay these off first.

5. Reduce Your Credit Card Limit

If cancelling your cards really isn’t an option, then reducing their limits will still have a positive effect on your ability to borrow from the Banks. As you repay your balance, also reduce the limit, making sure you always keep within the limit – any over limit fees are very detrimental to a loan application.

The bank looks at your card limit as a worst-case scenario. If you have limit of $10,000 on your credit card and a balance of $5,000, the bank will still look at it as if the credit card is maxed out.

 

6. Look into Debt Consolidation

Debt consolidation is where you take a bunch of different debts and wrap them up in one loan.

The benefits of debt consolidation can be;

·       a single loan can make it easier to manage payments and budgeting.

·       it usually means a lower interest rate.

·       it is often a loan over a longer period so the payments are generally smaller.

 

However debt consolidation does have its downsides with the longer period meaning more interest paid overall and it is not always possible in all cases.

7. Most Important of All – Always pay your debts on time!

Good account conduct is essential. That means always paying your debts on time and never going over your limit, or below zero in your account (or below your overdraft limit). Banks will decline applications with unarranged overdraft fees, missed payments, late payment fees and over account fees unless you have a legitimate explanation for why these happened. Not managing your accounts well = decline.