Applying for a mortgage? Max deposit or debt-free?

If you have credit card debt and a lump sum, is it better to pay off the debt or put the whole sum down as deposit? Many people approach their first mortgage, having saved up a lump sum as a deposit, but also having some amount of debt on their credit card or cards. Would the lender look more favourably if the card debt were repaid first or is it better to use the whole sum as a deposit?

At Compass Personal Finance, we meet many individuals and couples in this situation. Let’s try and illustrate the issues.

Over the last three months, we have had two couples approach us for advice with almost identical financial profiles. Both were looking to borrow about £200,000; both had £30,000 to invest and both had aggregate credit card debts of around £10,000.

All else being equal, we would recommend paying off the debt(s). This is because most lenders will calculate that a £10,000 debt will attract 5% interest per calendar month, and therefore £6,000 per annum. They would then deduct this sum from the couple’s income before calculating the multiple on which to base the mortgage offer.

On the other hand, putting down a deposit of £30,000 on a £200,000 property constitutes an 85% loan-to-value ratio, whilst putting down £20,000 (having paid off the £10,000 debt) works out at 90%, thus attracting a higher rate of interest.

However, the “85%” couple’s overall monthly outgoings would still be higher, given the continuing credit card debt. Any potential lender would perform an affordability survey with the couple, and would lend less (or not lend at all) on that basis.

Two couples – at first glance, two identical financial profiles – but…

In the case of our two couples, though, we did offer varying advice. The female partner in one of the couples was looking forward to a substantial bonus from work in six months’ time, and their credit cards were still on 0% interest. By contrast, the other couple had no such windfall in prospect and had much higher credit card rates.   

Having performed comprehensive affordability checks with both couples in advance of their applying to the lenders, we were able to advise each accordingly. This saved both the cost of applications that might fail.  In addition, our knowledge of every lender and their portfolios of policies allowed us to recommend different products to the respective couples.

The bottom line is, everyone applying for a mortgage is unique, so it is always worth talking to an independent mortgage specialist who can work through all of your costs, both now and going forward, including the hidden ones. Many lenders such as the banks will not undertake this exercise, and it is a costly case of trial and error with them, to see what they would be prepared to lend.
 
If you have any questions about the subject matter of this blog, or would like more information on any mortgage related point, please do not hesitate to call us or get in touch by clicking the button below.