Disclaimer:
The information on this website is for general guidance only and does not constitute financial or investment advice. Always do your own research and seek personalised advice from a qualified financial adviser or mortgage adviser before making financial decisions. All investments carry risk and past performance is not indicative of future results.
Key Takeaways
- Debt repayments reduce your borrowing power even with strong savings.
- Set a budget that includes a specific, automatic debt repayment.
- Target high-interest or smallest debts first to build momentum.
- Lower credit card limits to improve bank affordability checks.
- Debt consolidation can help, but weigh total interest costs.
Here at The First Home Buyer's Club, we get excited about helping first home buyers through the process of purchasing their first home. But often, this excitement is hit with a dose of reality when we discover the amount of debt they have on board. Debt is one of the biggest roadblocks we encounter when trying to help first home buyers along the journey.
Why Is Debt Such A Problem?
When the bank looks at providing a pre-approval, there are a few moving parts they consider when deciding whether to give you a 'Yes'. These are: deposit amount from KiwiSaver and savings, combined household income, and debt. Often we find the first two parts look promising, but if we uncover any debt, we have to re-adjust our sights.
Important: Banks look at debt as a negative because it takes away from your ability to pay your mortgage. Therefore, when assessing your loan application for approval, they factor in any debt repayments you'll have to make. This ultimately reduces the amount you are able to borrow for buying your home.
The Effect Of Debt On Your Borrowing Power
While it might seem easier to bury your head and ignore the problem, let's consider how debt affects your lending ability:
- $10,000 on a personal or bank loan will have the effect of reducing your borrowing amount by $53,000
- $10,000 of credit card debt has the effect of reducing potential borrowing by $46,000
Taking Steps To Reduce Your Debt
Now that you're armed with the motivation to get on top of your debt, here are our six tips to do it:
1. Create a Budget That Includes a Weekly Debt Repayment
If you are serious about buying your first home, a budget should be an essential part of your plan. A budget can be used to get a repayment plan on track and once you're at zero debt, these payments can become contributions to your deposit. The key part of budgeting is to include a weekly amount for debt repayment. Be sure to set your repayments up as an automatic payment, so it is set and forget.
2. Prioritise the Debt with the Highest Interest Rate or Smallest Debt
If you've got debts of various types (credit card, personal loan, hire purchase), prioritise them for focused repayments. Option 1: Prioritise the debt with the highest interest rate to minimise total interest cost. Option 2: Focus on the smallest debt which helps get the ball rolling and encourages you as you tick one debt off the list.
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3. Contribute Any Additional Cash to Debt Repayment
From time to time we come into some unexpected money, be it a work bonus or a tax refund. While the temptation is to spend it, try to keep your eye on the ultimate goal and use it to get rid of that debt quicker.
4. Make Efforts To Change Spending Behaviour
Getting on top of your debt is really only going to truly work with a committed effort to change the behaviours that got you into debt. Did you buy a new car on finance? A better approach is to re-adjust your sights to a car you can afford to buy from money saved. If you've got credit cards that you struggle to avoid maxing out, you should cancel them to avoid your credit repayments being wasted.
5. Reduce Your Credit Card Limit
If canceling your cards really isn't an option, then reducing their limits will still have a positive effect on your ability to borrow from the Banks. Reducing your credit card limits has two effects: firstly reducing your "available" funds to curb extra spending. Secondly, the bank looks at your card limit as a worst-case scenario. So even if you only have a balance of $5,000 on a $10,000 credit limit, the bank will still look at it as if the credit card is maxed out.
6. Look Into Debt Consolidation
Debt consolidation is where you take a bunch of different debts and wrap them up in one loan. The benefits can be:
- A single loan can make it easier to manage payments and budgeting
- It usually means a lower interest rate
- It is often a loan over a longer period so the payments are generally smaller
Note: Debt consolidation does have its downsides with the longer period meaning more interest paid overall and it is not always possible in all cases.
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