Published on January 2nd, 2018
How to tackle your debtsIf you’re looking to buy a new house or mortgage the one you’ve got, you’ll need to go through a credit check with your lender. When they’re assessing your ability to service a loan, lenders look at all of your existing debt commitments including credit cards, personal loans, vehicle finance or anything else that represents a liability.
In fact, even if your credit card balances are relatively low, lenders will take into account the credit limit. In their eyes, that’s a liability that might impact your ability to service a loan into the future.
What this means for you is that if you want a favourable outcome in the New Year, you’re well advised to start tackling those debts today. Here’s how to approach the problem:
1. Draw up a statement of affairsThe first thing you need to know is where your money is currently going and what your commitments are. This is a two stage process. The first is to gather all the information you need on your outgoings and incomings.
Get hold of all your bills from the previous twelve months, if possible. Don’t neglect annual costs like car registration and Emergency Services Levy, nor small costs like subscriptions or recurring charitable donations which can sometimes slip under the radar. Divide annual and quarterly bills so that you have a monthly cost for everything you’re obliged to pay out. Variable costs, such as groceries or entertainment, are addressed in the next step.
You also need to know what all your debts are, including their totals and each interest rate or other fee which they attract. List these out.
2. Keep track of spendingSome of your monthly costs will be variable. If you’re just starting to budget, they’re also likely to be very roughly estimated. This generally includes groceries, eating out, clothing, entertainment and gifts. For the purpose of the first step, put your best guess into the budget, but you should also keep track of your ongoing expenditure. It’s often a lot higher than you think.
3. Look for places to cut downYou should now have a working budget, which you’ll improve and refine as you gather more information about your real costs. For now, it will serve to show you whether you have extra money left at the end of the month. If you don’t, you’ll need to see if there are opportunities to reduce your outgoings. Do you use that gym membership? Can you take lunch to work instead of buying it at a cafe every day? Call up your insurance, internet and mobile phone providers and see if you can get a lower quote. It never hurts to ask!
4. Snowball the debtsOnce you have all the debts listed and a good understanding of your financial position you can start to pay them down. If you have any debts, including phone or utility bills, on which you have missed payments, these should be your first priority. If you miss three months of payments on any debt commitment, a default is listed on your file and can affect your credit rating for at least five years.
If you’re not sure if you have defaults, you can run a credit check online for a small fee.
Assuming that there aren’t any defaults, try using a ‘snowball’ approach to pay down the debts. Identify the one with the highest interest rate and direct all of your surplus funds to that balance – not forgetting to keep up with minimum payments on the others – until it’s paid off. Close that card and send the payment you were making to the next one in line. As you pay off each debt, the amount you can send to the next one grows or ‘snowballs’. An alternative approach is to target the smallest debt first, as paying it off gives you a morale boost and keeps you going.
Whichever way you do it, don’t forget to contact your bank and ask them to lower the credit limit to just above the current balance. Remember, lenders look at your access to credit as well as the credit you currently owe.
If you’re not sure whether your credit rating will hold you back from getting a mortgage, consider talking to a mortgage broker. They’re experienced in knowing what the lenders will look for and in helping people formulate a plan of action to make themselves appear to be better risks. With a few small changes now, you could have your pre approval early in the New Year!