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Home loan 101: Do personal loans hurt or help home buyers?

Katherine O'Chee

Wednesday 20 November 2019

For many Australians, buying a house is no easy feat. And with Uber Eats, Afterpay and Netflix all making headlines over the past year for potentially hurting our chances of securing a home loan, it seems like just about every little indulgence in the book could sink our dreams of owning a home. 

Then what’s the verdict on the good old personal loan

According to online lender ME’s General Manager of Credit Risk, Linda Veltman, a personal loan's impact on your home loan application depends on whether you have the means and ability to meet both repayments. 

“Existing personal loan commitments are factored into your home loan application by repayments being included in serviceability calculations and debt levels to determine whether applicants are able to meet the proposed commitments without substantial hardship.”

Some lenders use a calculation known as ‘debt-to-income’ (DTI) ratio, which determines the percentage of your monthly income (before tax) that gets eaten up by debt and household expenses. In general, the lower your DTI ratio, the better your odds of getting approved - but the bad news is, personal loans increase this ratio. 

RELATED ARTICLE: First home buyers in luck as APRA loosens mortgage restrictions 

Mozo’s Property Expert Steve Jovcevski said that with serviceability assessments already being tough tests to pass, a personal loan would only make mortgage approval that much harder.

“While a personal loan won’t make or break your chances of taking out a home loan, it’s always going to have a negative impact on your serviceability.” 

That's because any debt is a liability, and the more liabilities you have, the harder it would be for you to meet your mortgage repayments. For instance, if you’re spending $200 a month on personal loan repayments, that’s $200 less you have on hand to pay off your home loan. 

The silver lining of having a personal loan 

But it’s not all doom and gloom, said credit union CUA’s Head of Operations, Manuel Ledezma. 

“A personal loan provides an opportunity for you to demonstrate a positive repayment history, showing your ability to manage your finances and a commitment to managing and reducing debt.” 

By meeting your repayments every month, you can improve your credit rating. An excellent rating then tells lenders that you’re a responsible borrower, which in turn would boost your chances of getting a home loan and accessing the best rates.

RELATED ARTICLE: What does your credit score say about you? 

Making debt repayments before applying for a mortgage allows homebuyers with no credit history to start building up their credit file. 

Jovcevski explained that since lenders will check your credit score when assessing your serviceability, having a blank slate could be just as bad as leaving a black mark next to your name.

“Banks will always be skeptical if it’s the first time that you’re applying for credit. So if you’ve got a clean credit record but no inquiries, then that raises red flags.” 

Tips to boost your chances of home loan approval

It's no secret the home loan approval process varies from lender to lender, and borrower to borrower. As customer-owned bank Newcastle Permanent’s Direct Lending Manager, Greg Ferris, noted, “[it’s] important to remember that every financial institution will have different credit assessment criteria and that everyone’s financial situation will be different.” 

But to get you started, here are some tips to help you snag that tick of approval:  

1. Make repayments on time

Thanks to the introduction of Comprehensive Credit Reporting (CCR), lenders now have access to more information about you than ever before, including your repayment history. So when it comes to making repayments, maintaining a perfect track record by being punctual every month (for at least 3 to 6 months before applying) could land you a better home loan deal. 

According to Ferris, “making regular repayments on time or more than the minimum monthly amount will help demonstrate your savings ability.” 

Set up monthly reminders on your phone, and mark the repayment dates on your calendar. If your personal loan lets you make extra repayments without any penalties, consider taking advantage of this by putting any additional cash towards paying down debt. That way, you’re not only proving your trustworthiness as a borrower, but also slimming down your interest costs. 

And if you’ve got multiple debts - say, a personal loan and two credit cards - a debt consolidation loan could help you manage repayments more easily and save on interest. 

2. Pay off as much debt as possible

Once you finish making repayments on your personal loan, it’ll no longer be a liability and negatively impact your DTI ratio. So if you’re in no hurry to buy a house, it could be worthwhile delaying your application until you’ve cleared your debt. 

The key thing to make sure here, according to Ledezma, is that “the ongoing repayments for any personal loans or credit cards you have are in line with what you can afford.”

“If you need to, look to reduce the number of personal loans and cards you have to help give you additional borrowing capacity,” he added. 

But what if you’re hoping to snatch up a property right now while interest rates are at record lows? Jovcevski said if you had to choose between a 20% deposit with personal loan debt or less than 20% deposit with no debt, then the first route would possibly be the lesser of two evils. This option, at least, helps you dodge Lenders Mortgage Insurance (LMI) which could add up to thousands of dollars. 

“If you do that, just make sure you’ll be able to service both loans and speak to the lender to see if you still qualify.” 

Crunch the numbers and see how much you can afford to borrow with our home loans borrowing calculator

3. Minimise new credit applications

While having a credit history is important, it's equally important that you don’t go overboard by applying for too much credit. 

That’s because every time you apply for a credit product like a personal loan, you rack up what’s known as a ‘hard enquiry’. While one or two hard enquiries aren’t much to worry about, it’s when you make too many that this can become a problem, as it makes lenders think you’re financially careless or desperate for credit.

What if I’m a refinancer with a personal loan? 

It’s a slightly different story if you decide to refinance with a personal loan under your belt. Jovcevski recommended rolling that debt into your new home loan, as home loans generally have lower rates, which means your monthly repayments and interest costs for your personal loan would drop considerably. 

“But the trick with that is to make sure you aren’t stretching your personal loan repayments over 25 or 30 years, as this would have the opposite effect and increase the interest you’d have to pay,” Jovcevski said. 

“Instead, keep the loan as a separate split from your home loan and pay it off, say, over a five year period or over the same period that you would have originally had the personal loan. That way, you can get the maximum benefit on the reduction in the interest.” 

A split home loan is a feature that lets you divide your home loan into different portions or accounts - this split could be any ratio, such as 50/50 or 80/20. Some lenders may even allow you to split multiple times. 

So fear not - whether you’re refinancing or looking to purchase the property of your dreams, there’s usually a way to keep the negative effects of personal loans at bay. 

Ready to get started? Head over to our home loans comparison table to compare options today.

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