Credit Cards and Home Loans

Question

I am based on Sydney Australia. Looking to buy a house here. Customer of one of big 4 banks.

Long story short,

6 Months back

Talked to my bank about buying a house and discussed about my borrowing power. At that time i had 2 credit cards, 6K + 8K. I have utilized about 7K combined at that time. So bank told be to clear off the debts and reduce your credit card.

Then i managed to pay off debts and reduced the credit limit to 2K and 3K respectively.

At that time i did have a car loan too. So it made sense for me to wait.

Last Week

Right now i have debts of $600 in 2k and $900 in 3k credit card. re-applied for loan and bank didn't approve the requested amount. I had cash flow to pay repayments. One of the main reason is you have multiple credit card and limit on the credit card is high.

I don't understand this logic. If you reduce the limit less than that, you can not do any shopping. Can not buy a flight ticket or furniture etc.

I have paid off the car load about 3 weeks back (4 months earlier than usual period). They also said (in negative term) "You have just paid off your car loan, that is also one consideration for this decision"

I prefer to have 2 credit cards. I keep one always at home. all the bills and monthly commitments goes from that. Other one is used to carried by me. This is simply because i have very bad time after loosing my wallet last year which had my main credit card.

Question

1. Does a 5K limit is too much?
2. Why my settlement of car loan affected the home loan?
3. What is the rule of thumb for credit cards (number of cards and limits) when applying for home loan in Australia?

Thanks.

Answer 1

1. As a former banker, I would never advise having a higher limit than you need. This means that, if your limit is $5,000.00, I would expect your monthly net pay to be $5,000.00 or more. Why? So that you can pay it off in full.

2. It is unlikely that the discharge of the loan on your car would have been a negative in assessing your application. From a commercial perspective, your having fewer liabilities is a positive.

3. The reason why having a higher credit card limit is bad when applying for loans (not just home loans) is that you are generally assessed as having used the entire limit on the cards, rather than only what you have actually spent. This is because credit card debt is unsecured, and you can spend all of it at any time, and at that point, you would need to make larger repayments.
   In some cases, banks will offer mortgages that are conditional on your closing or reducing the limit on your existing credit cards, because it is such a liability.

Answer 2

When obtaining a new loan for a home, there are several factors which credit granting institutions will use, and as @jimsug states, the amount of available credit is one factor. But likely the ratio of credit used to credit available (in the U.S. this is referred to as credit utilization), is also considered, and that may be part of the challenge you face.

Factors that can affect credit decisions include payment history, age of existing credit, new or recent credit granted (or applied), mix of credit used (fixed, revolving, student, mortgage, auto, personal), amount of credit available, amount of credit used, credit utilization (ratio = used / available), payment history, and negative items (unpaid or charged-off debt). When buying a house (applying for a mortgage), or other large loan, the ability to pay is considered using the borrower's debt to income ratio (total amount of monthly payments / total amount of monthly income). The loan underwriter may assume that because you have $5k available, that you will use the $5k, and assume the payment needed to service that amount as part of your total monthly debt. The credit decision may even look at total amount of credit (revolving) and expect a certain total credit limit available.

When you look at the first scenario you disclosed ($7k used out of $6k+$8k=$14k), you were using 50% of available credit. When you look at the second scenario you disclosed ($600+$900=$1500 used out of $2k+$3k=$5k available), you were using 30% of available credit. The credit decision used might have viewed this utilization as high, and you might discuss with your banker whether they are concerned about the amount of credit available (total credit available), vs. utilization of available credit (amount used / amount available). Both may be factors, but the utilization may be what the banker meant by 'you have too much credit'.

Paying off the car loan may be an odd quirk of their system, where they might be including an expectation that since you paid off your car loan, you might decide to purchase another car. You might respond to that with details about your car (age, odometer, etc) and any other indications that you plan to keep the car. This is probably a debt to income ratio, and their caution about imputing a car payment.

You have not provided enough details. You mention $580k purchase price and 95% LTV (about $29k down), so you are asking a bank to loan about $550k. Are you applying for a fixed or variable rate loan, what is the interest rate, what is the monthly payment, what percentage would the payment be of your monthly income? Do you have assets/savings to handle employment disruption, what are your employment prospects (young, growing field, increasing income)?

The house payment on $550k in the U.S. would be around $2500/month, and using the rule of thumb that you should limit your rent/mortgage payment to 25-28% of your income, thus you would need an income of $10k/month ($120k/year). A less publicized rule of thumb is limiting your mortgage to less than 2x or 2.5x times you annual income. It is possible the bank has no intention of granting the loan, but is being polite to retain you as a potential customer, when you find a more affordable house.