Ever since the Mortgage Market Review came into force in 2014, mortgage lending criteria has tightened and lenders must ensure borrowers can afford the mortgage they are offered. This means they have to examine applicants’ finances closely, including how much debt they have. If you’re hoping to apply for a mortgage in the near future and you have credit card debt, you may therefore have concerns about how this could affect your chances of being accepted. In this article we look at whether having credit-card debt can affect your mortgage application and whether you should clear your debt before applying.
Can I get a mortgage with credit-card debt?
Many people believe they won’t be able to get a mortgage with outstanding debt. But while it can make getting a mortgage more difficult, it doesn’t automatically mean you won’t get one. Although credit-card debt can affect your mortgage application, it is one of several factors that will be taken into account when lenders weigh up whether you can afford a mortgage.
When you apply for a mortgage, lenders will scrutinise your finances. As well as taking your income into account, they will also examine your spending habits to establish how much they think you can afford and how much they will let you borrow. They will look at how much you spend on regular household bills, childcare costs, commuting costs, and socialising, as well as how much you spend on credit-card or loan repayments. They will also stress test your finances to see if you could afford an interest rate hike.
How much debt is acceptable for a mortgage will depend on each lender’s criteria, but as a general rule the lower your debt-to-income ratio (how much debt you have as a percentage of your income), the better. Your credit utilisation - which is calculated by dividing your total card debt by your available credit limit and multiplying by 100 - will also be taken into account. Experts recommend you keep your utilisation rate below 30%.
Lenders will also assess whether you are a reliable borrower and have made your credit-card repayments on time. Missed or late payments can be a sign you are struggling financially and can make mortgage providers more reluctant to lend to you. Your lender may also want to know why you got into debt in the first place. If it was due to an emergency such as a new boiler, for example, they may be more lenient than if you have built up debt simply by spending too much on items you didn’t need.
Is it better to clear credit-card debt before applying for a mortgage?
If you have savings, it is usually better to use them to pay off existing debt. This is because the rate of interest you will be paying on outstanding credit-card debt is likely to be much higher than the rate of interest you would earn on your savings. Clearing your debts may also mean a mortgage provider will be more inclined to lend to you and it will improve your credit score which can help you to get accepted for better mortgage rates.
If paying off your debt will wipe out your savings, another option is to pay off a portion of your debt and use your remaining savings to put down as a deposit for a house. This will lower your debt-to-income ratio (which will please lenders) and may make better financial sense if you are spending a lot on rent, particularly as mortgage rates are currently so low. Shifting your remaining debt to a 0% balance transfer credit card can help you to pay it off more quickly and cheaply as you can avoid paying interest for a number of months. Bear in mind you’ll need to pay a transfer fee and once the 0% deal ends, you'll start paying interest. You will also need to ensure the credit limit on the card is sufficient to meet your needs. Find out more about balance transfer cards in our article: "Best 0% balance transfer credit card deals".
If you are unable to pay off your credit-card debt before applying for a mortgage, it can help to show the lender that you have a plan to clear the debt soon after buying a home. Some lenders may allow you to borrow more if you have a clear plan you will stick to, but be aware that others won’t as they have no guarantee you will actually do it.
What is the maximum amount of debt you can have when applying for a mortgage?
There are no specific rules on the maximum amount of debt you can have when applying for a mortgage, as lending criteria can vary between providers, but it is usually best to reduce it as much as you can.
However, if you use funds saved for a house deposit to pay down your debt, your reduced deposit will affect the rate of interest you are offered on a mortgage. The very best deals are often reserved for those who can put down a deposit of around 40%, giving them a low loan-to-value (LTV) of 60%. On the flip side, if you can only put down a deposit of 5%, giving you an LTV of 95%, you’ll be offered higher interest rates. Dividing your required mortgage amount by the value of the property and multiplying this figure by 100 will give you your LTV.
This can make the decision about paying off debt more complicated. Let’s say you have £10,000 in credit-card debt, £25,000 in savings and you are looking to buy a house for £160,000. If you use the £25,000 in savings for a deposit, you would have a LTV of 84%. This means you won’t get the very top mortgage rates, but you won’t get the most expensive either, so you might decide to proceed with your mortgage application, even though you still have debt on your credit card.
Alternatively, you might decide to pay off the £10,000 of credit card debt and in so doing reduce your deposit to £15,000. This would increase your LTV to 90% and therefore push up your mortgage rate. However, the fact you have no credit-card debt could also work to your advantage.
If the amount saved was much higher, on the other hand, say £45,000, paying off your debt is likely to make the most sense. In the example above, you could clear the £10,000 of card debt but still have a £35,000 deposit, giving you an LTV of 78% and access to better mortgage rates.
To help you make the right decision, it can be a good idea to speak to an independent mortgage broker such as Habito*, as they will be able to talk you through your options. Check out our independent Habito review for more information. A mortgage broker can also provide guidance on whether you would be better off having less debt but a smaller deposit or vice versa. You can find out more about mortgage advisers in our article: "The 7 best questions to ask a mortgage adviser".
How to increase your chance of a mortgage application approval
Before you apply for a mortgage, try to pay off as much debt as you can afford to so that you lower your debt-to-income ratio and your credit-utilisation rate. Certainly, pay off more than the minimum each month and make sure you don’t miss any repayments. Having debt won’t necessarily mean you are turned down for a mortgage but it can affect how much you borrow and the rate of interest you will pay on your mortgage. It may also help to consolidate debt before applying for a mortgage - in other words, combine all your debts into one monthly payment. This can make it easier for lenders to understand your finances.
If you manage to pay off your credit cards, you may wonder whether you should close your credit cards before applying for a mortgage. Closing unused credit cards can be a good idea as it lowers your overall credit limit, but keeping them open can lower your credit-utilisation rate which may help lenders to regard you more favourably. We discuss the pros and cons in our article: "Will cancelling an unused credit card affect my credit score?"
It is also worth checking your credit rating through one of the three main credit reference agencies, Experian, Equifax and TransUnion before you make a mortgage application. If your credit rating isn’t up to scratch there are steps you can take to improve it such as checking you are on the electoral roll and correcting any mistakes. It can also help to reign in your spending before you apply for a mortgage, and cancel unwanted subscriptions.
Finally, it’s worth getting all your paperwork in order, such as proof of address and the last three months of your payslips if you are employed and if you’re a first-time buyer, take a look at our guide: "Everything you need to know about buying your first home".
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