Mortgages: debts versus deposits

You certainly need some money behind you to get on the property ladder in the 21^st century and how much depends on which kind of scheme, property or even lender you use, not to mention the area you intend to buy in.

How do debts and savings work together when it comes to securing a mortgage?

Many of us have debt and a significant amount of us have both debts and savings. Any financial adviser worth their salt would usually suggest using your savings to clear debt as you invariably pay a higher interest rate on your debts than you receive on your savings, so that’s basic financial sense. However there can be a paradox when it comes to applying for a mortgage.

As we’ve already touched on, you need a certain amount of cash to use as a deposit for your purchase and to pay moving costs like stamp duty and legal fees. The larger the deposit (in 5% gradients), the lower the interest rate offered by the lender, so putting in the biggest deposit you can could reduce your monthly mortgage repayments significantly.

If you have debt, the flipside of this is that since the Mortgage Market Review was implemented in the UK in April 2014, banks and building societies have largely ditched the simple ‘X times your salary’ calculation used for determining mortgage capacity in favour of ‘affordability-based lending’. This means a more complex set of criteria and calculations are combined to work out what maximum monthly repayment is affordable should rates rise by a certain amount for each individual application, be it sole or joint.

This is where there can be an issue if you have debts (or other regular monthly outgoings like childcare or maintenance payments). Essentially, if the debt has more than six months left to run at the time of application or is a rolling credit arrangement like a credit/store card or overdraft, then monthly repayments towards this can reduce the maximum borrowing amount offered by the mortgage lender.

So, the question is: should you pay off your debt with your savings before applying for a mortgage or not?

The answer is not simple; consideration also needs to be given to the fact that repaying debt improves your credit rating which also plays a part in the application process. Every case is different, of course, and many lenders view different types of debt differently, so as always bespoke advice is needed.

This becomes even more apparent when you consider how if you are borrowing well within your mortgage capacity, have debts but can reduce your interest rate by using more of your savings in the deposit amount then it may be prudent to do so. If you need to maximise your borrowing but have debts, then repaying them will help and if it leaves you short on deposit then maybe now is not the right time to commit.

Sounds confusing? There is good news…

The Euxton team deal with these issues daily; balancing what is right for clients, making carefully calculated judgements and advising on the course of action that is most suitable for each one. Why not give us a call today?

September 2018