Will personal loans affect my mortgage application?

A personal loan isn’t completely bad news in the eyes of mortgage lenders. Read on to see how your personal loans can affect your mortgage application. 

Any debts you have can have an impact on your mortgage application.

As part of the application process, mortgage lenders will evaluate your credit history, including your auto loans, credit cards and personal loans. This will help lenders determine how much you can borrow and if you are qualified for a mortgage. 

But don’t fret. If you are still in the process of paying off a personal loan, your mortgage application may still be approved. If used strategically, a personal loan may even help you attain your dream of owning a house.

Keep on reading to see how your personal loans can affect your mortgage application. 

How personal loans positively affect your mortgage application

A personal loan will not completely throw a wrench in your mortgage application, as lenders don’t generally view personal loans as bad news. 

Lenders do not solely focus on your credit score or history when they check your mortgage application. For the most part, they will evaluate if you can afford the monthly payments in the first place. This is where your personal loans will come into play. 

A personal cash loan is a lump sum of money borrowed from a financial institution that you repay in fixed monthly payments or installments over an agreed period of time. If you are responsible with your loan repayments and consistently pay them on time, it will ultimately boost your credit score.

A high credit rating tells lenders that you are a responsible borrower, which in turn will increase your chances of being approved for a home loan and getting the best rates offered. 

If you have paid off your personal cash loan responsibly and have not missed any repayments, it will have no negative effect on your mortgage application. 

It is even recommended to take on some debt or credit repayments during the months leading up to your home loan application to increase your credit rating. To achieve this, most applicants strategically pay a portion of their bills through direct debit or make monthly card credit card repayments. Repaying a personal loan will help you get the same results. 

 How personal loans negatively affect your mortgage application

One of the main concerns of lenders when checking your mortgage application is how your personal loan will impact your overall spending power.

A personal loan’s effect on your mortgage application will depend on whether you have the funds and ability to meet both repayments. When you apply for a home loan, lenders conduct a serviceability assessment, which determines your ability to make repayments based on the size of the loan and the borrower’s income and expenses.

Existing personal loan commitments are factored in during serviceability calculations as well as debt levels to determine if the borrower can fulfill the proposed financial commitments of the mortgage without difficulty. 

Some lenders calculate this through a debt-to-income (DTI) ratio, which determines the percentage of your pre-tax monthly income that is used up by debt and household expenses. The lower your DTI ratio is, the better the chances of your mortgage application being approved. On the downside, personal loans increase this ratio. 

A personal loan will not make or break your chance of getting approved for a mortgage loan, but it has a negative effect on your serviceability. Any form of debt is a liability, and the bigger your liabilities are, it will be harder for you to commit to your mortgage repayments. If you are spending $100 per month on personal loan repayments, it is $100 less at your disposal to meet your monthly mortgage repayments. 

Additionally, lenders will perform a hard pull credit inquiry each time you apply for a personal loan. These checks lower your credit score for a short period, so it is advised not to apply for too many personal loans in the months leading to your mortgage application.

Missing out on your repayments for your personal loan will also affect your application negatively. This behaviour tells lenders you’re an irresponsible borrower, which can leave a black mark on your credit history for a long period of time.

Will payday loans affect my mortgage application? 

Payday loans are regarded by most mortgage lenders as “bad debt”. Lenders tend to disregard all applications made by borrowers who have taken out a payday loan in the last 12 months before their home loan application. 

A number of lenders will even reject your mortgage application if they see a short-term loan on your credit history up to six years before your application. But some lenders take into consideration other factors, including your loan-to-value ratio and any other credit issues in your financial history. 

How to boost your chances of mortgage application approval

The mortgage approval process differs for each lender and borrower, but here are a few tips that can boost your chance of getting that green light for a home loan: 

 1. Make repayments on time. 

Managing personal cash loans responsibly is one of the best ways to increase your chance of your home loan getting approved. A good track record on your  personal loan repayments will boost your credit score, and your chances of being approved for a mortgage. On the other hand, late repayments hurt your chances of getting a mortgage.

Maintaining a good track record at least three to six months before applying could help you get a better deal. Set monthly reminders on your calendar when you should make your repayments so you won’t miss it. 

If you are paying off multiple debts, consider getting a debt consolidation loan, which helps you manage repayments more systematically while also saving on interest. If you can make extra repayments without additional charges, allocate any additional money you have on hand towards paying debt. This will increase your credibility as a borrower while lowering your interest costs. 

2. Pay off your debt as soon as possible. 

If you have completed your repayments on your personal loan, it will no longer be a liability and will not negatively affect your mortgage application. If you are not able to immediately pay off your loan or you’re not in a rush to buy a house, you can consider delaying your application until your debt is cleared. 

The key thing is to ensure that the ongoing prepayments for any personal loans you have is still within your spending capacity. Reducing your debt will boost your additional borrowing capability. 

3. Reduce new credit applications.

While it is necessary to have a credit history, it is equally important that you minimise your new credit applications. 

As mentioned, any credit application racks up a hard pull credit inquiry, which can lower your credit score by a few notches. While one or two inquiries will not cause significant damage to your rating, making too many will hurt your credit and make you look financially negligent and desperate for credit. 

But if you are faced with an unexpected major expense that requires you to take on a personal loan, be strategic when you are “shopping” for one. Use a loan calculator to determine how much your payments will be and how to pay it off sooner. 

Conclusion 

Your personal loans can have a negative or positive impact on your mortgage application. 

To keep these negative effects at bay, be responsible in your repayments and be strategic on how you manage your debt. Be informed about the process and avoid fudging your mortgage application to lessen the odds of facing rejection. 

Additionally, take advantage of the benefits a personal loan can give to your application to increase your chance of securing your dream home. 

Are you applying for a home loan? You can arrange a convenient time to speak to Jesse Bruno, our mortgage broker at Centra Money by clicking here.

Article reproduced from Nest Egg by Zarah Mae Torrazo

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Zac Zacharia (Managing Director) has been assisting clients to create wealth and secure their futures for over 14 years.

He is also an accomplished presenter and educator

Co-authoring the popular investment book, Property vs Shares.