Boost your Borrowing! Why your car could be keeping you off the housing ladder...
Have you noticed recently how many new cars you see on the road? The headlines are full of stories about how squeezed most family incomes in the UK are, and yet it’s no longer uncommon to see shiny new cars driving around, often with young people behind the wheel. Here I am (only in my 30’s), harking back to the sepia-toned images of my youth, but I certainly don’t remember anyone I new having a new car in their parent’s driveway. So what has changed?
Well the world has been on an ever-increasing credit binge since the late 1950’s, with various options being developed to allow buyers to get anything from holidays to mobile phones without having to save up the full price ahead of time. Cars are no exception, representing the second most expensive purchase most people will ever make, after their home. More recently, historically low interest rates have made car finance a very tempting option for anyone considering a new or used vehicle. Why drive an old banger when you could be driving a brand new car tomorrow for just over £100 per month? 85% of private car registrations last year were paid using some sort of finance deal. These finance deals have made it possible, and especially with young people remaining in their parent’s ‘nest’ for longer, the disposable income is out there begging to be used on something shiny and fast.
Why that new car hurts your mortgage power
As I have mentioned here previously, the mortgage lenders are applying ever more scrutiny on borrower’s spending habits. (I’ve been asked to justify every individual payment of over £100 for the last 12 months before.) So you can imagine that any regular car payment will not escape the attention of lenders.
There are two main ratios that lenders can look at while deciding what to lend you – your income to debt ratio and your housing costs to total income. These give the lender an impression of what you are likely to be able to set aside for the mortgage, allowing for your existing commitments and the likely costs of running a home (including a mortgage). If you earn really well, but spend almost everything each month then the lender has to decide if they trust you to cut back on spending to meet your new mortgage payments, or not. Since the days of a bank manager knowing you by name are long gone, you can guess how that is likely to go. This is only part of what they will look at to make their decision, but it is important.
In fact, many of your unconscious spending habits could be hurting your borrowing power – so here are my top tips to boost your borrowing:
- If your total debt isn’t excessive, it will be your monthly spending that matters, not the amount owed. This means that if you took out a £10,000 car loan on a five-year repayment term, one year before applying for a mortgage, you would be able to obtain a larger mortgage than someone who borrowed the same amount over two years and had therefore paid about half of it off.
- If you must have a shiny motor, go for a 2-3 year old car instead. You’ll be borrowing thousands less due to depreciation, it will still be under warranty, and you’ll barely notice the difference from a brand new car.
- Avoid payday loans like the plague. In addition to being a total rip off, they signal to lenders that you struggle to manage your finances.
- Pay off all loans and credit cards by Direct Debit. This ensures that you never miss a payment by accident, which could hurt your credit score.
- Make sure that you stay within your agreed overdraft. Showing that you can stick to a financial agreement will be a positive signal that you can be trusted with the bank’s money.
- If family members are helping with the deposit, make sure you have a letter showing that the money is a gift and not a loan – otherwise your borrowing ability may be reduced as the bank expects you to have repayments to make. Once the mortgage is through, what you do with your money is up to you, of course (so long as you pay the mortgage every month)!
- Run your finances as if you already have a mortgage. Make sure you’re putting at least the expected repayment cost into savings every month for 6 months ahead of your application.
Why some borrowing is essential
So am I suggesting you should never borrow credit before applying for a mortgage? Absolutely not – in fact it is almost essential that you do. Lenders are trying to assess the risk that you won’t meet repayments, and they will be reluctant to do lend if they have no evidence of past behaviour to go on. So simple things like putting your shopping on a credit card and then paying the balance off every month, or taking out a mobile phone on contract will actually help boost your borrowing by showing you can be responsible with the lender’s money. I highly recommend signing up to the free Money Saving Expert Credit Club, which will allow you to keep track of how a lender might view you – and give you a chance to adapt ahead of time.
It’s both enjoyable and tempting to have a new car in the driveway, but you have to consider the impact this could have on where you can afford to live. Indeed, this could even apply to existing landlords affected by the issues I raised in last week’s blog. As ever, these are complex issues and your personal circumstances will vary, so speak with a financial advisor or mortgage broker before making any important decisions. Happy motoring, and borrow wisely!