Many financially stable and credit-worthy buyers are left gobsmacked when their home loan applications are denied based on factors they thought they had covered.
They do not realise that having unused credit on a retail account or credit card is viewed negatively, or that seemingly minor things can count against them.
These include late payments and unresolved disputes with companies that may even be in the wrong, says Cobus Odendaal, chief executive of Lew Geffen Sotheby’s International Realty in Johannesburg and Randburg.
“All too often we see financially stable and generally credit-worthy buyers having their property dreams scuppered by long-forgotten debts, often innocently overlooked because of circumstances like moving house.
“And, although they may have originally been small amounts, legal fees and penalties can escalate the amount owing and sometimes there is even a judgement against them.”
Knowledge is therefore crucial when it comes to managing your credit.
“The more you understand about the factors that affect your credit score, the easier it will be to maintain a good rating, especially if you are planning to apply for substantial finance like a mortgage.”
What banks look at when reviewing your home loan application
Although the two most critical requirements when applying for a home loan are a good credit score – with a track record of repaying contractual debt responsibly, and being able to afford the monthly bond instalments, he says banks also take several other factors into consideration.
“For instance, a factor which one would expect to count in an applicant’s favour is having high, but unused, credit available on retail accounts and credit cards. But the opposite is true.
“Banks will automatically include the potential instalments on these unused credit facilities in their affordability calculation, with the rationale being that the applicant could at any stage max out his/her credit facilities.”
So before you apply for home finance, Odendaal says you should either reduce your retail credit limits or close unused accounts so that your affordability isn’t prejudiced.
He also advises that, in the time leading up to your bond application, you limit any other finance applications to only those that are absolutely necessary. This is because too many credit inquiries, whether they are for a credit card or a loan, can negatively impact your score.
Affordability and income are not the same
As an aspirant homeowner, you should also know that there is a difference between affordability and gross income, both of which the banks the banks take into consideration.
“As a rule of thumb, the larger the margin between gross income and expenses, the better the rate that applicants are likely to be offered. So I always also advise people to not go buy a brand-new car just before they apply for a mortgage.”
A good credit score is vital and the best way to establish this is consistently over time, Odendaal says. If you have a “scant record” then you should start with small accounts like store credit and cell phone accounts, and try to include a credit card in the mix.
“Keep your debt low and always pay on time, paying more than the minimum instalment when possible.”
Although the Credit Amnesty Bill implemented on April 1, 2014 stipulates that credit bureaus must now automatically remove paid-up judgments and paid-up adverse information listings, he says banks still have access to payment profile information that displays payment histories.
Be wary of your credit card debt
Among the many checks that banks carry out when deciding whether to approve your application or not, is the amount of debt that you have at that time, as well as the deposit you can pay, says Nondumiso Ncapai, managing executive at Absa Home Loans.
She says there are a range of factors that influence an individual’s borrowing risk and their likelihood of being approved for a home loan. These include:
– Actual expenses
– Credit profile or credit record
– Current credit exposure (i.e. how much debt you currently have or are owing to creditors)
– The term of the loan
– Amount of the loan being applied for
– The property to be mortgaged
– Whether you have a deposit or not
Data analytics and consumer credit reporting company Experian, advises that, in most cases, it makes sense to pay off credit card debt before buying a home. This can increase your credit score and decrease your debt-to-income (DTI) ratio, both of which may qualify you for lower mortgage rates.
“Merely having credit card debt likely won't disqualify you from buying a home,” the company states in an article, “but it may negatively affect you in other ways—for example, in the way mortgage lenders view you as a potential borrower”.
This is how:
– Credit card debt increases your DTI. One of the most important elements of your mortgage application is your DTI, including your projected monthly mortgage payment. The greater your credit card debt, the greater your DTI, and the higher the likelihood your mortgage application may be denied.
– Credit card debt impacts your credit score. Lenders look closely at your credit score and at the details in your credit report, including the types of debt you owe and their balances. Paying down credit card debt lowers your amounts owed, which is a major factor in your credit score.
– Credit card debt limits the mortgage payment you can afford. If you're making a substantial credit card payment each month, taking on a mortgage could be a strain. Not only will lenders take this into account when evaluating your application, but your budget could be overburdened.
“In most cases, paying off credit card balances – or paying as much as you can to bring their balances down – is the right move. You'll be able to lower your DTI and, hopefully, increase your credit score and qualify for a lower interest rate on your mortgage.”
To have a better chance of being approved for a home loan, Vivienne Cox of ooba Home Loans agrees that you should try to settle your debts.
“When banks look at a potential home buyer’s profile, they check their credit history and risk profile. Although settling an outstanding debt does not automatically guarantee a favourable credit score – as the repayment history of a debt remains on your credit record for two years – good debt management can work in your favour as the banks can only assess what you will do with credit if they can study your repayment track record.”
You should also try to pay the balance owed on your credit card as this has a strong influence on your credit score.
“Paying back your credit card balance has a significant impact on your score, as it’s not just about having the credit, but how you deal with it that the banks are assessing.”