Will a personal loan affect my mortgage application?

Buying a house for many Australians can be difficult. You may have taken out credit cards and personal loans previously with no issue so assume that a home loan is no different. However, when you apply, you discover that even the smallest of your expenses seems to impact your chances of getting a home loan. So you ask the question, will a personal loan affect your chances of getting a home loan?

Mortgage lenders need to ensure that you’re capable of meeting your monthly repayments before approving your application. As part of reviewing your application, they’ll most likely evaluate your credit history, including credit cards, savings, and even closed and existing personal loans. This analysis helps the lender determine how much you can comfortably borrow and then repay if they approve your home loan application.

Essentially, a personal loan’s impact on your home loan depends on whether you can meet both sets of repayments without facing any financial stress.

How do personal loans negatively affect your mortgage application?

Most lenders usually use the debt-to-income (DTI) ratio when assessing your home loan application. This ratio determines the percentage of your pre-tax monthly income available to pay your debt and other household expenses. The lower your DTI ratio, the better it is for your application. Any form of debt is a liability, which leads to an increase in this ratio, including your personal loan.

The main concern that most lenders have while checking your application is how your personal loan impacts your spending power. When you apply for a home loan, the lender will assess your income and compare it to your expenses, including your personal loan’s monthly repayment. For example, say you’re paying $100  in monthly personal loan repayments, that’s $100 less available for your mortgage repayments.

Also, if you miss paying your personal loan repayments, it can impact your credit score. Any change to your credit score directly affects your mortgage application. This behaviour raises a red flag for lenders as it indicates that you’re an irresponsible borrower.

Do personal loans positively affect your mortgage application?

Lenders don’t always consider a personal loan as bad news when assessing your mortgage application. While lenders evaluate if you can afford the monthly repayments, they also give high value to your credit score. This is where a personal loan can help you move closer to an approved home loan. 

If you’re responsible with your personal loan, are consistent and timely with repayments, it will ultimately boost your credit score. A high credit score indicates that you’re a low-risk borrower, which will likely increase the chances of getting a home loan approved and access to better interest rates.

How can personal loans be used to boost your chances of home loan approval?

1. Don’t miss repayments

With the introduction of Comprehensive Credit Reporting (CCR), lenders can now access more information than ever before about your credit history. This increased access to information makes it more important to stay on top of your personal loan repayments and maintain a positive track record. Doing this will boost your credit score and help you land a good home loan deal. You could even consider making repayments that are more than the minimum monthly amount, as it demonstrates your ability to save.

If you have multiple debts, you could consider debt-consolidation through your home loan, which will help manage your repayments easily, while saving on interest.

2. Pay off or close as much debt as possible

A closed personal loan is no longer considered a liability and therefore, doesn’t negatively impact your DTI ratio. So, if you’re not in a hurry to buy a house, you could consider clearing your debt first before applying for the home loan. Also, if you’ve got multiple credit cards, consider closing or reducing the limit on a few to reduce your DTI ratio. This will then increase your chances of getting a home loan approved.

3. Don’t overdo credit applications

Having a personal loan that is repaid on time can work wonders for your credit score. But, it’s important not to go overboard by applying for too much credit. Every time you apply for credit like personal loans, you will undergo a hard enquiry on your credit history, expenses and debt. A hard enquiry then appears on your credit file, and too many hard enquires can impact your credit score. Also, if you have too many on-going hard queries, lenders might think you’re financially careless or desperate for credit.

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