New rules came into play on 1 January 2019 relating to credit cards. These unrelated new rules could have an adverse impact on your borrowing capacity when it comes to applying for a home or investment loan.
Previously, when a lender assessed your borrowing capacity for a home or investment loan, they assumed your credit card would cost you 3% of the full credit limit (not the outstanding balance) as a monthly repayment.
For example, if you had a $10,000 credit card, this would eat up $300 of your monthly disposable income for serviceability purposes, resulting in a reduction in your borrowing power.
Under new government regulation, effective 1 January 2019, credit card applicants are required to demonstrate they have the capacity to repay the credit limit in full within 3 years, in order to be approved.
As a country, Australians have clocked up $51.6 billion in credit card debt with $152.1 billion in credit card limits (as at 31 December 2018). Government intervention was inevitable.
When it comes to applying for your next home or investment loan, the impact of a credit card limit is now even harsher as banks/lenders are aligning the 3 year repayment rule as part of your servicing capacity.
Rather than the 3% rule, your bank/lender will now allocate 3.75% of the full credit limit (not the outstanding balance) as a monthly repayment commitment. Some lenders may even use a higher percentage, time will tell. Using the same example as above, if you have a $10,000 credit card, this will eat up $375 of your monthly disposable income for serviceability purposes, which will
further reduce your borrowing power.
This applies for any type of mortgage you apply for, including property purchases, refinancing, and equity release. Same rules apply across the board.
If you’re like many clients I come across, you probably have credit cards which you don’t use, or you have high credit limits which are over the top and never use.
My advice is to get rid of any unused credit cards. And any credit cards you decide to retain, be ruthless with the credit limit and reduce it to the lowest point you feel comfortable with.
Many of our clients don’t use credit cards as a loan, rather they use them for convenience and to accumulate points to enjoy the many benefits that come with accumulating credit card points.
Whilst this is a great feature and a great benefit of a credit card, the bottom line is that you can’t have a higher borrowing capacity for a mortgage and a higher credit card(s). It’s one but not both.
Credit cards have their place, but now more than ever you need to be ruthless with the credit limits for any cards you plan to hold onto.
Disclaimer: This information does not take into account your individual objectives, financial situation and needs. You should assess whether the information is appropriate for you and seek specialist advice from a qualified and licensed advisor.