Personal loans are great things, opening the door to purchases for which saving is difficult, or just digging you out of a financial hole with a stable regular outgoing. From debt consolidation to a brand new car, unsecured personal loans are part of many families monthly outgoings, but there’s one question we are often asked at The Mortgage Hut:
Will a personal loan affect my mortgage application?
The very short version of the answer is ‘yes’.
Personal loans and mortgage applications make bad bedfellows, because each is a stretch on your monthly outgoings. However, all is not lost, and simply having a personal loan doesn’t mean you won’t be approved for a mortgage.
Personal loans and risk assessment
A successful mortgage application is all about presenting yourself to the lender as a low risk. How does having a personal loan affect that risk assessment?
High levels of debt
Having a high level of debt outside of your mortgage is a considerable risk. It means that the strain on your income is great, and you have other regular obligations that may take away from your commitment to your mortgage (although, for most, the mortgage is the primary debt payment each month).
In short, it means that you may struggle to repay the mortgage.
Lenders will look at your debt to income ratio as part of their affordability tests. This is derived by the following:
(total monthly debt payments) / (total gross monthly income) * 100
The lower your DTI (debt to income), the less risk you represent. A personal loan will have a significant impact on your DTI calculation. Consider that with a gross monthly income of £2,300, every extra £115 paid out per month in debt raises your DTI percentage by five points.
The majority of personal loans in the UK are between £5,000 and £10,000 and represent monthly repayments of £180 to £250 per month. For most people, this means their personal loan raises their DTI by at least 7% - a significant figure.
Poor money management
Mortgage lenders may want to know the reason for your personal loan. If it is for an activity such as a holiday, then it may be perceived as a poor decision to prioritise such an expensive trip prior to looking to secure a mortgage. Whereas a personal loan as part of a debt refinancing plan would signal that there has been poor money management in your history.
Of all the reasons for personal loans, car purchases and home improvements are the least likely to give cause for concern.
Desperation
The worst reason for a personal loan is if you have taken one in financial desperation. This can mark you as a serious risk for a mortgage lender and may put your application in jeopardy. While a standard personal loan with your bank is unlikely to signal desperation, payday loans are a strong indicator that you have been struggling on a day-to-day basis.
For this reason, many lenders will simply reject applications from customers who have a recent payday loan on their record.
Another indicator of financial struggle is multiple loan applications in a short space of time. Each time you make an official loan application, your credit history is marked - and too many of these marks in the same month can raise questions with lenders. It is for that reason that we suggest waiting three months from your last application for credit before putting in your formal mortgage request.
Deposits and personal loans
We are often asked if it is possible to get a personal loan to finance the deposit for a home purchase. While the answer isn’t a strict ‘no’, the reasons detailed above should show that it is not without difficulties.
When it comes to your deposit, the mortgage lender is looking to feel comfortable that you are in a secure financial position and are taking on some of the risk of home ownership yourself. A deposit financed through a personal loan doesn’t show those traits, however, it is a better proposition for the provider than a 100% LTV mortgage (no deposit mortgage).
A lot will depend on your income and other outgoings - your affordability. If you have a very significant income, and low outgoings, the extra pressure of personal loan repayments for the first few years of your mortgage may be insignificant. In these cases, a mortgage lender may be willing to offer a deal on those terms. However, if your finances are such that the personal loan repayments and the monthly mortgage repayments combined are a strain on your finances, then the mortgage lender is unlikely to be willing to undertake the risk.
Use the debt-to-income ratio calculation described above. If your DTI is 25% or lower with both the prospective mortgage and personal loan repayments considered, then the mortgage lender may be willing to overlook the unorthodox method of your deposit.
Example #1:
Tim earns £50,000 per annum, his wife, Susan, earns £62,000. Their combined income provides a gross monthly income of £9,333.
Their current debts, car finance and relevant outgoings (without mortgage or rent) comes to £540 per month.
Their proposed mortgage deal would cost £1,850 per month.
Tim intends to use a personal loan for the bulk of the deposit, the monthly repayments are £460.
The total cost of their debt outgoings per month, with mortgage and deposit loan is: £2,850. Considering their income, that’s a DTI of 30.5%. Even with their considerable income, mortgage lenders would be most likely to reject their application in this way.
If Tim and Susan saved for their deposit, rather than fund it with a personal loan, or if they lowered their other debts and outgoings, they would stand a better chance of success with their mortgage application.
Example #2:
Simon earns £54,000 p.a., a gross monthly income of £4,500.
He has very little current debt (only a credit card) and currently his monthly debt is only £95.
He is looking for a mortgage with repayments of £650 per month and has no savings, so is looking for a personal loan to cover the deposit. The loan he is looking at has a monthly repayment amount of £265.
His total outgoings with the loan, his credit card, and the mortgage would be £1,010. This is a DTI of 22.44%, which would be considered low enough by some lenders to approve the mortgage, even with the loan providing the entire deposit.
Savings and loans
Having outstanding debt when applying for a mortgage is never a good idea, whether that is with credit cards, overdrafts, or personal loans.
From the mortgage lender’s perspective, it is difficult to justify the idea of having saved for a deposit, and still have outstanding unsecured debt.
While it may not seem the same as taking out a personal loan to fund a deposit, if you have significant savings to put as a down payment towards your new home and yet are relying on loans and credit in other aspects of your life, then it is very similar in essence to using a loan for the deposit.
In almost all cases, it is prudent to pay off all existing debt with your savings before putting it towards your deposit, so that when you go forward with your mortgage application you are 100% debt free.
It will save you in interest too! Interest rates on loans are always higher than those you are gaining with your savings. If you are receiving 1.5% per year on your savings, but paying out 7% on a personal loan, it’s not doing you any financial good to hold onto the savings account.
For first time buyers, who are typically using a cash deposit, it is never a good idea to enter into a mortgage application with outstanding personal debt if it is possible to clear the debt.
For those moving from one property to another, planning to utilise the equity in their current home as a deposit for the move, the situation is a little more complicated. As the funds are not readily available, it is not unlikely that there is personal debt in addition to the current mortgage. In these situations, however, the principle is still the same, and the freed equity that comes from the house sale should clearly be earmarked to pay off outstanding borrowing of all types to allow a debt-free move into the new property.
Student debt
Long term student debt is considered separate from shorter term unsecured personal debt, and there is never pressure from a mortgage lender to clear student debt prior to a mortgage application.
Secured debt
Other secured debt, such as car finance, will be taken into account in any debt-to-income ratio calculations, but there would be no expectation to pay it off prior to making a mortgage application.
Credit management before a mortgage application
In the months before your mortgage application, we advise that you take a very detailed look at your own credit history and do what you can to reduce the amount of your debt and other outgoings.
In the UK, you can check your credit rating with the three credit reference agencies (Experian, Equifax and TransUnion) for free via their websites. There are other online tools available that can help further, but these may come with a usage fee.
Knowing in advance what exists on your credit report that may affect your mortgage application gives you the opportunity to put it right, pay off any unsecured loans and credit cards, and approach your lender as a low-risk customer with strong money management skills.
Getting a mortgage with The Mortgage Hut
At The Mortgage Hut we’re here to help you get a successful application by looking at your personal circumstances and approaching the right lenders, with the right mortgage products to suit you. Our team of experienced specialists will be able to assist with every aspect of your mortgage application, with advice throughout the process.
Fill in our contact form today to have an advisor get back to you, or simply pick up the phone and call!