As you embark on the exciting journey of becoming a homeowner, it's crucial to lay the groundwork right from the start. One vital consideration is addressing any existing personal debt, as it directly impacts the amount you can borrow for your mortgage.
So, what exactly constitutes personal debt? These encompass credit balances and loans from various sources like store cards, credit cards, car loans, student loans, and personal loans, to name a few. In simple terms, it's any financial obligation that you, as a consumer, may have. Some financial literature even includes the mortgage on your home under personal debt, though for our purposes, we'll focus on all debts excluding a mortgage. After all, as a First Time Buyer, you wouldn't already have a mortgage.
Now, why is it crucial to consider paying down or reducing your personal debts, if you have any? Well, the primary reason is that the money allocated to servicing this personal debt—those monthly payments—is money that can't be directed towards a mortgage. When mortgage lenders assess how much they're willing to lend you, they take into account these other obligations. So, the more debt you carry, even if you meet your monthly payments consistently, the smaller the mortgage amount they'll extend to you.
But you might wonder, isn't some debt considered beneficial? Indeed, having a track record of credit in your history is positive, as it provides assurance to potential lenders. Your credit history also reveals if you've been punctual with payments or if any have lapsed into arrears and defaults. Late payments, arrears, and defaults raise concerns for lenders, implying an elevated risk of the same happening with their loan. Demonstrating responsible money management behaviour by paying on time and managing debts appropriately reassures lenders of your creditworthiness. However, it's important not to accrue debt solely to establish a credit record—there are alternative approaches, which we'll cover in a future post.
Now, onto strategies for paying off personal debt:
Debt Snowball: This method involves listing all your personal debts and arranging them by size, with the smallest debt at the top. Then, make over-payments on the smallest debts while maintaining minimum payments on larger ones. Once a smaller debt is settled, roll that payment into the next smallest debt. This approach builds momentum and provides a tangible sense of progress.
Debt Avalanche: Arrange your debts by the interest rate, starting with the highest. Similar to the Debt Snowball, you'll overpay on the highest-interest debt while making minimum payments on the others. Once you've cleared the costliest debt, you move on to the next, using the money that was previously allocated to the first debt. This method minimizes overall interest costs, allowing you to pay off debts more efficiently.
Remember, the method you choose is less important than taking proactive steps to reduce your personal debts. Money directed towards loan repayments and interest is money not contributing to your deposit and could also affect the size of your potential mortgage.
Starting early to reduce your debt is a wise move. It not only aligns with good financial practice, but also leads to a less stressful financial outlook in the future. Fewer debts grant you greater control over your finances and expand your lifestyle choices. In time, it could be the key to an early retirement, or the freedom to work fewer hours without sacrificing your financial security.
Now that you're armed with the knowledge to navigate your personal debt on the path to home-ownership, it's time to take that crucial first step. Start by assessing your own financial situation and consider which debt reduction strategy resonates with you the most. Remember, every pound you save on interest payments is a step closer to securing your dream home.
Take a moment now to jot down your next action. Whether it's creating a debt repayment plan or exploring additional resources, being proactive will set you on the right track. Here's to a future filled with financial stability and the keys to your very own home
Here's to empowering you with knowledge, one penny at a time, on your path to home-ownership.