Whilst you do not need to be completely debt-free to secure a home loan, you will need to demonstrate that you have been responsible with your finances. This means proof of regular, on time payments of existing debt, and regular, steady increments to savings accounts. All of this adds to your ‘credit character’, which is how the bank analyses you and decides whether you’re the type of person they want to lend money to.
As a first home buyer it is important to ensure that you are home loan ready and have reduced your debt as much as possible. We have put together some steps to make this process simpler for you.
Step 1 – Work out how much you spend
This is important for anybody but for buyers in particular we suggest you first work out where exactly your money is going and how much you could (or should) be saving. We typically walk clients through this when we discuss living expenses, but it’s a great idea to do this in advance.
We’ve made this easier by providing a budget planner, but there are also some other free apps like PocketBook, Mint and TrackMySPEND. It takes a bit of time and effort, and can also be a bit of a shock, but setting a budget is well worth it in the end for the massive insight you gain.
Step 2 – Decide where you need to cut back, and be realistic with it…
Now that you have an actual visual representation of where your money is going each month, it should be clear where you can and should cut back. A word of advice – be realistic. Don’t tell yourself you are going to cut back on that weekly wine purchase, or your monthly online shopping spree if you know deep down this is something that you won’t actually go through with.
It’s important to remember that even those small changes can make a huge difference over time. If you have a coffee every weekday (let’s say at $4.00 per cup), instead of having a free one from work, you will be spending $20 a week that you really don’t need to. Although $20 per week might not sound like much, that’s over $1,000 a year that could be in your pocket. What could that mean? Well $1,000 is how much we typically budget for a conveyancer when you purchase a house, so guess what? Now that’s covered! Maybe save the barista for the weekends and really earn it? If coffee is a non-negotiable for you, maybe there’s something else you can cut back…? The point is that with even the smallest of lifestyle tweaks, you will have access to more money which means you will be (or should) be able pay off your debt faster or put it towards your house deposit. It also creates great habits for when you do have that mortgage for the home you worked so hard to get.
Step 3 – Check your outgoings are worth the $$
It might seem like a pain, but checking your bills for better deals, your insurance premiums and your internet providers, can end up saving you a lot of money in the long run. You might not have to go through the effort of changing providers, but even just asking them the question “am I getting the best deal?” could save you.
Similarly, do you have a subscription to an app, a program, or even perhaps that gym membership that you’ve never used? Cancel them! They might not seem like much right now but when you add them all up, they really are. That $15 per week you are paying for a gym membership that you have never used, is costing you nearly $800 a year! Shopping around for the best deal for your situation is vital and so is getting rid of those extra expenses that you know deep down you don’t need.
Step 4 – Pay off those credit cards!
Having a credit card can be a recipe for disaster. When you have a credit card, most of the time you will find yourself spending more than you can afford, or way more than you really need to spend.
If you have a credit card for emergencies only, like emergency pet trips, or a leaking dishwasher, then it can definitely be a bonus, but be sure to only get a credit card with the lowest limit possible. What many people fail to realise is that the bank assesses you on your credit cards limit, not just how much you have spent. Sure, you might never use that whole $18,000 limit, but the fact is that you could, and the bank will consider this when working on your borrowing capacity for your house. Consider a limit that’s realistic for a real emergency situation and bring it down to that.
As you pay off interest on any unpaid amount, you are just paying interest on top of interest, and eventually you can end up with quite a large debt, especially if you don’t stop your spending. When you eventually apply for a loan, lenders will look very closely at how you have managed your credit card, in particular, how often you used it and how often you made repayments.
Step 5 – Make those credit card repayments on time.
This step is really just an addition to step 4… You need to be aware that your repayment history is going to be captured in your credit file for each line of credit you have. This even includes your payments for bills – if you miss these payments, or are late on them (even just once), all of this information is recorded in a file which will lower your credit score and each time you miss a payment your credit score will continue to decrease.
With open banking now active the lenders will see even more detail and really understand your behaviour. If you’ve been not so great at managing a credit card then the obvious conclusion for them to jump to is that you’ll be just as bad or if not worse with a much bigger home loan debt.
Lastly, step 6 – Increase those savings!
This again goes back to showing good behaviour and creating your ‘credit character’. If you are wanting to get that home loan as soon as you can, it is vital that you save as much as you possibly can. As we’ve said in other articles, ideally a 20 per cent deposit is what you should have saved, but the point is that anything that you’ve saved yourself will help.
Most lenders would like to see that your deposit has come from ‘genuine savings’. This is the term lenders use for the money that you have saved yourself gradually over time rather than received in one lump sum from say selling a car, a gift from your parents, an inheritance, etc. Generally speaking, most lenders require at least 5% of the money you’re putting into the purchase to have been built up over 3-6 months. However, do remember that each lender is different, and some will consider the fact that you’ve been paying rent as genuine savings. This is because it shows you’ve been able to stick to a routine of meeting a big expense like rent that otherwise would have gone to savings or paying a mortgage, which is what you’re applying for.
So then, the overall take away from this is that it’s a good idea to better understand where your money is going and set yourself savings targets. We really do urge all potential first home buyers, no matter how far away that is, to use our budget planner and have a chat with us about what you find from it. Contact marketing@credofinancial.com.au to get your hands on one.
At the end of the day the reality is that the more savings you have, the more likely you will be in a better position to get the home loan and interest rate you were hoping for.
