Deciding how much to borrow is a big question, and a loan sets you up on that crucial first step towards your financial goals, such as buying a house or a new car. But getting a loan is also heavily weighted by what's on your credit history.
If you haven't already, you should check out our full blog on credit scores (where we go into more detail on the subject). In short, if you've applied for a loan, taken out a credit card or paid a bill, you'll have what's called a 'credit score'. Lenders and bankers use a ranking system to determine the interest rate they'll charge you. If you have defaulted on a few loans or taken out an extra card, you might have a low credit score, which in turn could lead to being charged a high-interest rate.
This should make borrowing a home loan impossible, right? Well, it all depends on how you apply. Some banks might approve you for a personal loan if your credit score isn't great — but it'll prove more challenging because of their strict standards. Lenders will also look at your income and expenses alongside your repayment ability.
How much should I expect?
Generally, for banks, it's 2-2.5 times your salary. So if you earn $50,000 a year, that's between $100,000-$125,000. Lenders will let you engage in a little more risk — 4.5% and upwards.
You can check how it works out by using an online calculator. Please have a play with the interest rate; it'll tell you what your expectations are, should rates go up. Banks and lenders also have online calculators if you want to shop around for specifics.
When securing your loan, you might encounter something called a 'UMI' (Uncommitted Monthly Income). This is the minimum 'surplus' or leftover cash, expected to be in your account each month. Remember — that's after any fixed payments or living allowance. The more you borrow, the more 'surplus' is expected.
Is it an excellent decision to borrow then?
In short, yes. An income-based loan can be used to build up your credit score over time, lowering interest rates across the board. Essentially you're adding to your financial history with a positive track record of payments.
If you want to find out your credit rating, then Yonda can help. As a credit scoring app, it allows you to track your progress over time and figure out how to make changes to improve your chances of securing better credit. We've got some general tips in this blog, which will help.
Make payments on time.
If this is a problem, you'll want to figure out what you can afford based on that 'surplus' we talked about above.
Consider your credit mix.
By that, we mean how many credit types (i.e. loans, cards, etc.) you've taken out. It's a minor factor, but every little bit contributes.
We've written all about how great KiwiSaver is and how to apply it in another blog. In short, the longer you have one of these, the better. You can withdraw money from your KiwiSaver to help purchase your first house and save for your retirement.
I am applying for a loan.
The best way to get the ball rolling is by contacting a lender or bank directly. When you do, they're going to want to know some information about you. Banks, in particular, might require payment evidence in the form of your last three months of bank statements.
Lenders also undergo their checks. Key things to listen out for:
When banks, finance companies and other providers run your credit file, notes are made on how you handle payments like bills and debts. When this happens, a hard pull is made on your credit file, which can hurt your score. Quotation enquiries give you an idea of where to go to get the best price for a loan but won't have any lasting effect on your credit score.
They'll access your income and bank account information and might not look at your credit score. But for that, they'll typically charge higher interest rates — so be careful.
While an unsecured loan may have higher interest loans, secured requires some form of collateral — that can be anything significant you own, such as a car or house (if you already have one).
Taking out a home loan is a big deal, but it doesn't have to affect your entire credit history. Think of it this way — nearly everyone who currently owns a house, or runs a business, will likely have had to take out a loan at some point. It's just a part of life — no one expects you to have all the money for a big purchase just lying around.
But if you think it's time to borrow, consider how you're going to pay it back first. That way, you get the best interest rates for now and in all future credit transactions.