Your Homeloan Also Depends On Your Credit Card!

If you have (too) many credit card and you are thinking about getting a homeloan/mortgage, you need to read this article carefully. Yes, your credit card could actually the one determine whether you get approval for that home loan or not. Even you are not using that credit card at all! And you cannot really lie about it as it is documented in your credit history. So, what can we do about it ? Fortunately, not that difficult.

All about Loan Serviceability

When you apply for a home loan on a mortgage, it’s all about loan serviceability. A bank or other lender only want to know whether your income can pay for the loan – in other word whether your income can “service” the loan. This is what they call as “loan serviceability”.

This is how it works. Let say if you want to borrow $500,000 with 5% interest rate and you only take the “interest-only” loan.

1. Hence you need to pay the bank $2083 monthly.
2. The bank will now taken into consideration of the living cost. They have standard table for your local city/area based on number of children, age of the children,  your marital status, etc. For example: In Sydney, family with both parents working with 2 children below 5 years old will have more expensive living cost compare to Family with boths parent working but with 2 children between 5 and 10. Well the reason is because the cost of child care is more expensive than primary school cost.
   Let say for this example the living cost is deemed to be $2500 per month.
3. Then the bank will now look into other loan: car loan, personal loan, shop card, credit card, etc. They need to know how much you need to pay/service those loan monthly. Let say your monthly obligation is $500 monthly.
4. So, total from 3 items above will be:  $5083 monthly

This is where the notion “cash flow is the king” come into effect. From example above, your income (can be combined with your spouse/parter) HAVE TO BE more than $5083 monthly or $61k per annual after tax. Some lender will prefer to have also additional safety band and add 10% or more into the calculation. But basically this is how it works. Your income have to cover this monthly commitment.

But how about if you have quite some money sitting in the bank, say: $100,000 sitting on the bank? Nope, it wont help. The amount of money you have in the bank will not affect your serviceability above, because:

1. You can spend those money without any control from the bank/lender anyway
2. Without regular income, the amount of money sooner or later will be depleted.

(You can though, withdraw this amount and make it as additional deposit so instead of borrowing $500,000 you only borrow $400,000 which in turn will reduce your serviceability criteria)

Your Credit Card Reduces The Serviceability

Some people will always pay off the monthly expense on the credit card, but some other people won’t. So, the bank or lender will assume the worse. If you are committed with the new loan that they provide and you have some kind of financial difficulties, the chances are you will max-ed up your credit card and pay only the minimum amount. So, this is the calculation that will be used by the bank.

The typical minimum amount to pay each month from a credit card will be around 2%. So every $10,000 credit card debt you will need to pay at least $200  monthly. So, in example above, as you pay 5% for the home loan, then additional $200 monthly will be equal if you borrow additional $4,000. Therefore in other words, every $10,000 credit card limit will cost you $4000 home loan serviceability. Although this example is mathematically correct, we will never know the exact calculation that the lender do when it comes to reducing the serviceability. Therefore , I would recommend this rule of thumb:

Reduce the serviceability by the same amount of the credit c ard limit.

So, if you have a few credit card with total credit limit of $50,000 then if you think you can service $500,000 home loan, then with because of this credit card limit, then expect that the bank will only allow you to have $450,000 home loan.

Even if you don’t use the credit card at all, the lender will assume you will use all of the credit. This is quite unique to credit card as for other type or fixed loan, such as car loan, if you already pay off 75% of the loan, then your “obligation” will be only calculated as only the rest of the 25% of that loan.

Things that You Can Do

There are 2 easy things that you can do to help with this issue:

1. Close the credit card that you never use. Ask for the closing statement (the one which explicitly mention in words that you have closed your account)
2. Reduce the credit limit to your comfortable level (read this article about maximize your credit card benefit before decide). Make sure to ask the statement that explicitly mention that you have reduced your credit limit.

The statement about your account closing or limit decrease is quite important. Why? The bank/lender knows that you have a credit card from other bank (from your credit history check) and you will be most likely be asked to provide the latest statement, but a change of credit limit or closure is not that obvious (they cannot really check it) – hence you just provided it for your own benefit.

Also you can do: close all of your credit card except 2 (read Benefit of having 2 (two) Credit Cards of Similar Value) and consolidate all of your credit card debt into your new home-secured loan. Remember home loan is the cheapest loan around, so maybe it’s a good ide to have them all consolidated.

As final word, remember that getting a new home loan should not change your lifestyle dramatically (you won’t survive as home loan is long term commitment). Also credit card should be just your convenience tools. So you need to balance between these two:

• don’t push it to the highest home loan possible by increasing your serviceability by closing credit card account such that you have no convenience anymore -or-
• having too much credit limit in credit card so that your home loan serviceability is too small.

Well, you decide – no one else does. Good luck !

Credit History: An Important Document You Can’t Deny

Credit history is simply a record to all your activities in the past in relation with loan and debt. It’s not only all your personal loan, homeloan/mortgage, car loan or credit card account that you apply are there, it’s may also contain all the subscription that you have such your post-paid mobile account and even electricity/gas account.  And the most important content is what have you done with all those accounts. Such as:  have you ever not paying your rent or mortgage? Have you ever declare yourself bankrupt? How many times you did not pay your bill (or even late paying your bill) ?, etc. Yes, all of those information are available to all company, of course with your consent. Can you start feeling its importance ?

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Debt is Good: Only for Investing & Business Though

When business and investment people are asked, what sort of criteria to make a investment or a business is an ideal one. One of the item high on the list is that the investment or business should not used their hard earn money. In other words: taking other people money (OPM) or having a debt.

On separate article (Debt Is Bad: Insight From Franklin and Gandhi), I have explained why having a debt is not really a good thing, especially if the debt is used for acquaring any kind of lifestyle product.  So, what is the different now, why suddenly debt become a good thing to have ?

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In Debt & Loan World: Cash Flow Is The Most Important

So you want to take a loan (either it’s a credit card, personal loan, car loan, or even home loan)? Then you need to make sure that your cash flow is in a good shape. It’s not the balance of your saving account nor total debt of your credit card that is more important. It’s the amount of money that you earn (and then spend) during specific period or “cash flow“.

Let’s compare John and Bill condition below as they are trying to get a personal loan:

• John: Have $5000 cash in his saving account, income $400 per week, living expense about $400 a week.
• Bill:  Have no saving (well, few dollars) but earns $800 per week, living expense is about $700 per week.

Who do you think in a better position to get another loan, say for a car loan?

Both John and Bill have a steady weekly income, while Bill earns more than John, but Bill doesn’t have any savings. John have $5000 on his saving account. But the most important item here is that Bill have positive cash flow: earns $800, living expense $700, hence he got $100 per week called ‘disposable income‘. Yes, the fact that he did not put some of the money into his saving account, that could be something need to be improved from Bill. But he does have a cash flow to serve the new loan.

Let say the new loan will require a repayment of $250 per month for the next 5 years – typical car loan. John with his $5000 could serve the loan for 20 months only. (And could be less if John decides to take some money from his saving account for something else – no one can prevent this: if he wants to use it, then no body can prevent him).

On the other hand, although Bill doesn’t have any savings, since he has the cash flow, the lender will be confidence that Bill will be conviniently re-pay the loan within 5 years and granted the loan to Bill.

Maximize Your Cash Flow In Front Of Lender: Some Tips

So, if you want to make sure you have maximum chance to get a new loan, you need to show to the lender that you have enough cash flow to serve the loan:

• Mention all of your income (even casual or ‘informal’ one). For example: you have $50 most of the week baby sitting your neighbor kids, but you don’t declare this to the taxman. You can mention this additional income to the lender.
• Mention also all benefit from government including social security payment, grant, scholarships, allowance, etc where you actually received some money.
• Be ready with the list all your expense in monthly or weekly period and determine which expense can be eliminated to create more room to repay the loan.
• Show the lender that you actually have a budget, even in very simple form like excel spreadsheet or note in your agenda. Mention that you have been following that budget with discipline.
• Usually the lender is not comfortable if you have credit card with high credit limit, although you don’t use the credit, the lender will assume you will use them all and repay the minimum. In this case, you may choose to reduce the limit or put in writing that you will reduce the limit the next day.
• Maintain your credit history: never forget to pay your bill, always tell your creditor if you have some dificulties to work out some plans.

Remember: never apply a loan for lifestyle, for example: holiday loan, or car loan (to upgrade to better model, etc) or even worse ‘TV loan’. Taking a debt is justified if you use the money for something productive that will produce more money.

Good luck with your new loan !