When life throws out surprises, running up a credit card debt is often unavoidable. You might worry that carrying debt will put you in a weaker position for a mortgage – would a bank really want to lend money to someone who has had to borrow elsewhere?
Well, fear not – a loan or credit card debt won’t necessarily stop you from getting a mortgage. But the amount of debt you have will certainly influence how much you can borrow.
This guide lays out how mortgage lenders judge applicants with debt, and what you can do to help ensure your mortgage application is a success.
How do mortgage lenders view debt?
A common belief among home buyers is that any kind of debt will ruin your chances of being approved for a home loan.
But in reality, mortgage lenders will look at a number of factors, including the type of debt you have, the circumstances around it and how it affects your overall financial health.
A key factor banks will consider is your ‘debt-to-income ratio’ – how much debt you have as a percentage of your income. The level of acceptable debt to income ratio will vary from lender to lender, but generally the lower your debt to income ratio, the better.
‘Good credit’ versus ‘bad credit’
Aside from looking at how much you owe, lenders will look at the ‘spread’ of your credit, meaning the number and types of credit cards or loans you hold.
Some types of loans may be seen as lower risk to banks – a car loan, for example, may not be a major problem for them, particularly if you use the car to get to work. Payday loans, on the other hand, are considered a major red flag by most lenders. For some, even a fully repaid payday loan could prevent a loan being offered for at least 12 months.
At the same time, mortgage applications are not based entirely on maths. Most lenders will be interested in the back story – why did you run up debt and what are you doing about it today?
Lenders will often be more favourable if you can point to a single event that required immediate payment, like home renovations or an illness, than if you simply over-spent.
Find out more: Improving your mortgage chances - how you can strengthen your application
How much mortgage can I borrow if I have debt?
Before approving a loan, mortgage lenders will run affordability calculations to work out whether you can afford to meet your payments.
As part of this assessment, lenders will look at your level of debt repayments, including credit cards, car loans, student loans or an advance from your employer. They will then add these repayments to your monthly expenses, and weigh this up against your income.
Find out more: How much can you borrow? - how mortgage lenders work it out
Most lenders will assume that you’re making monthly repayments of between 3% to 5% on credit card debt and factor that into their affordability calculations.
Taking that into consideration will reduce the potential amount you have to comfortable meet your mortgage repayments and any other outgoings you have an could affect the amount you can borrow.
If you’re buying the property with a partner, affordability assessments may also take into account any debt the partner is carrying.
In rare cases, the bank may be willing to split a couple – so, for example, use the husband’s deposit and run affordability on the basis of the wife’s income. However, this is fairly uncommon and you should expect most banks to look at both partners’ debt and income levels together.
Does the amount of credit I use matter to mortgage lenders?
When you make a mortgage application, banks will take into account how much credit is available to you and how much of it you are using. This is known as the credit utilisation rate, calculated by dividing your current debt by your available credit limit.
Generally, it is recommended to keep your credit utilisation rate below 30 percent. However, this is not a hard and fast rule, and lenders will use their own formulas to assess your application.
Some people believe that keeping card accounts open will lower their utilisation rate. But having a higher overall credit limit, even unused, can damage your application’s chances. To have the best shot, you should consider closing unused cards and keeping your balances as low as possible.
This table shows how credit utilisation rates may be calculated.
What if I plan to pay off my debts soon after getting a mortgage?
If you have a plan to pay off your debt in full before you buy a property or soon after, banks may be willing to factor this into their affordability assessment so that you can potentially borrow more than you could with the debt. They may even make paying off your debt a condition of their mortgage offer.
However, many lenders are wary of doing this – there’s a difference between saying you’re going to pay off your debts and actually doing it!
Some may agree to subtract 50% from the debt amount, on the assumption that this is how much you’re likely to pay off. Others will not subtract anything at all, and make their calculations assuming you will just repay at the minimum rate.
Find out more: How to plan your budget - work out a realistic plan for paying your bills
Will a debt management plan affect my mortgage?
When you’re swamped with debt, starting a debt management plan or getting a payment holiday can seem like a reprieve.
Both these strategies may help you out in dire circumstances. However, both also impact on your credit history, and you should carefully consider the potential effects before going ahead.
Under a debt management plan, you meet a portion of your repayments each month over a set time period. Often, companies are happy to agree to an arrangement like this because it helps them recover some of the outstanding money.
However, paying less than you owe each month may be recorded as a series of defaults on your credit record – which over the course of several months can enormously damage your credit rating. Even after you’ve completed your plan, you may have to spend more than a year repairing your credit history before being able to apply for a mortgage.
Similarly, payment holidays offered by lenders can occasionally end up being recorded as defaults on your credit history. If this happens to you, contact the lender and ask for the defaults to be removed.
Find out more: How to improve your credit rating
What should I do before applying for a mortgage?
If you have debt, coming up with a plan before lodging your mortgage application is likely to improve your chances. You should consider:
- Closing unused credit card and loan accounts
- Paying down your debt to bring down your credit utilisation rate and debt to income value
- Building up your credit history with regular payments
- Using a specialist lenders - while they generally charge a higher interest rate, they also tend to be more flexible on affordability assessments and credit histories
- Be honest about any loans, including car loans, employer loans and student loans
Personal advice on getting a mortgage with credit card debt
If you want help finding a mortgage deal that suits your circumstances, we'd recommend talking to Which? Mortgage Advisers. Call for a free consultation on 0800 197 8461 or fill in the form below for a free call back.