Not all debts were made equal. When it comes to buying a house, some debts can be helpful and some, well, we could really do without. Let's take a look at the different types of debt and how they might affect your home loan borrowing capacity.

Personal loans and secured car loans

Personal loan debt reduces the amount of income you have to service a home loan, in turn potentially lowering your borrowing capacity. Personal loans also often have higher interest rates. If a variable interest rate is attached to your loan, lenders may also add on a buffer to allow for future interest rate rises.

Secured car loans usually offer lower interest rates than unsecured personal loans as the loan represents a lower risk to the lender. This means that while a secured car loan will still affect your borrowing capacity, it might not have as big an impact as an unsecured personal loan.

On the flip side of this, a fully paid off car loan can help your application. Demonstrating you were able to always make your car loan repayments on time could make your home loan application stronger.

Student debt

Your income versus your expenses forms a big part of the home loan application assessment. Unlike most debts, student debt affects the income side of the equation. As at 1 July 2019, once the minimum repayment income threshold is met, the repayment rates start at 1% of your income and increase as you earn more, up to a maximum of 10% of your income. How much you earn determines how much you pay back, and in turn, the effect this debt has on your borrowing capacity. Various lenders may assess student debt differently, but regardless of how they choose to treat it, student debt is likely to have some impact on your borrowing power.

Existing mortgage

If you already own a home – congratulations! This is such a wonderful achievement. Although buying your first home could have left you with a sizable amount of debt, it’s not all bad news! If you've lived in your home for some time you may be able to tap into your equity to produce a larger deposit for your second property. Any income from investment properties could increase your borrowing capacity and help your loan application.

Credit card debt

Credit card debt can be quite confusing, and there’s a lot of conflicting advice around its effect on getting a home loan.

It’s common to hear that credit cards will help improve your credit rating. While not a total myth, a more accurate statement would be that credit cards can help improve your credit rating – if you’re responsible. Using credit cards responsibly can help demonstrate to lenders you’re a reliable, low-risk borrower. How you pay other recurring expenses, such as phone bills and even gym memberships, may also contribute to your credit rating. For more information on credit ratings and to learn how you can get a free copy of yours, visit ASIC’s Money Smart website.

Lenders don’t just look at your credit card balances and repayments. What’s also important to them is the credit limit of each card. If you have multiple credit cards and think this could affect your borrowing power, it might be a good idea to speak to a lender and discuss closing some card accounts or lowering their limits to see if this will help your home loan application.

Shared debt

If you’ve taken out a loan with someone else this makes you a co-borrower, and to most lenders you and your co-borrower are both jointly and individually liable for the debt. This means that if the other person was unable to repay the loan, you’re then fully responsible for the outstanding balance (and vice versa). This doesn’t matter if the person you share the loan with will also be on the home loan. But if they’re not, that debt is considered all yours and this could significantly affect your borrowing capacity. If you’re in this situation and want to improve your borrowing capacity, some lenders might be willing to only take into account your share of the debt if you can provide proof the other co-borrower can pay theirs.

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Published 18 November 2022