We all know that credit card debt isn’t ideal financial planning, but when it comes to securing a home loan, the limit you have on your credit card can also be a pitfall, says Brendon.
Allow me to begin with a personal disclosure … I'm personally in favour of having credit card limits as big as possible! [Audible gasp]
I use this as part of my risk management strategy. Meaning that I can have quick access to funds if I need them. However, if I had the personality type that “spends to the limits” then this would be a disaster in the making.
So, for me, I don't want to reduce my credit card limits, but, when applying for a home loan, sometimes reducing your credit card limits has one particular benefit.
Many times a week I sit down with homebuyers to fill out the mortgage application form. Down one side of the form we fill out the assets of my clients and down the other side we fill out the liabilities. We go through the liabilities, home loans, personal loans, hire purchases, credit cards, student loans and so on.
Very often, when we get to the credit card section, the conversation goes like this:
Client: "No, I don't have any credit cards."
Me: "Do you actually have any other credit cards that aren't used?”
Client: “Oh, yes, we do have credit cards but there's nothing owing on them.”
This doesn’t make a difference to banks.
From a bank's perspective, they consider your credit card debt to be the limit that is set on that card and not what you actually owe (if anything).
So, if you have a $10,000 limit on the credit card you hardly ever use, the bank will, in effect, consider you to have a $10,000 debt that you need to be able to service. When income is tight for a home loan, if we reduce that limit, sometimes we can get a deal approved where we couldn't get it approved if the credit card limit existed.
The ironic thing about it (and at least slightly disturbing) is that I've had situations where clients sit down in a bank to sign up accounts for a new home loan (of which we had previously reduced the client’s credit card limits as part of the approval process) only to be offered, by that same bank, a new credit card to go along with the home loan—go figure!
I guess, in fairness, when assessing a home loan, the banks have a legal obligation to ensure their clients can afford to service the loan. The only logical explanation then is that the servicing for a credit card is less stringent than the criteria for a home loan. (Note: I'm not actually sure if this is true.)
So, in summary, reducing your credit card balance when applying for a home loan can make a difference and is one potential strategy to get the property you desire.
Brendon Ojala is a Registered Financial Adviser with Velocity Financial. No investment decision should be taken based on the information in this blog alone. A disclosure statement is available free of charge upon request.