How do you reduce your home loan repayments? Well, your debt-to-credit ratio has a lot of power. It determines your creditworthiness, your borrowing power and even your interest rate. Understanding yours can help you save a small fortune on your repayments over the life of your loan.
A debt-to-credit ratio measures your financial responsibility, which is why lenders use it to decide if they can trust you with a mortgage. It’s a metric that represents how much credit you have available to you and how much of it you’re actually using.
The ‘debt’ portion of the ratio is calculated on your revolving debt. Revolving debt includes lines of credit and credit cards, but not debt with fixed repayments like a car loan or other mortgages.
What’s a good debt-to-credit score?
According to credit bureau Equifax, a debt-to-credit ratio of 30% or less is ideal. So, for example, if you have a total credit limit of $50,000 based on your income and assets, you should aim to keep your outstanding revolving debt below $15,000.
The better your rate, the better your credit score and the larger the pool of lenders who will open their pockets to you. You’ll get better rates and the power to negotiate better terms.
If you have a high debt-to-credit ratio, you might still be approved for a loan but your interest rate will be higher because you can’t prove financial responsibility. After all, lenders have to leverage their risk.
How debt-to-credit ratio can affect your repayments
Here’s an example. Let’s say John has $50,000 of available credit and an outstanding credit card balance of $12,500. His debt-to-credit ratio is therefore 25%.
John gets a $750,000 home loan and a 6% p.a. interest rate since lenders see him as a reliable borrower. John’s monthly repayments are $4,496.
Now let’s say Samantha has $40,000 worth of credit but has used $20,000, giving her a 50% debt-to-credit ratio. This is a red flag for lenders, who give her a higher interest rate of 6.25%. Her repayments are $4,693 per month.
Over a 30-year loan, that’s an additional $44,000 Samantha will pay on her home loan.
How to reduce your debt-to-credit ratio
Changing your ratio means finding ways to hit the 30% target or below. You can use some of these strategies to get you there:
1. Take a holistic look at your debt.
Do an audit of all your existing debt to see where you are financially. It might help to ask a professional financial adviser for help if you have more debt than you feel comfortable with.
2. Consolidate, consolidate, consolidate.
Turning multiple debts into one single loan can help you simplify your finances and hunt for a competitive interest rate.
3. Tap into balance transfers.
While it might seem counter-intuitive to get another credit card, a balance transfer feature can help you get out of debt faster. Balance transfers on credit cards allow you to move credit card debt to a new card with no interest payable for a promotional period.
Many cards allow you to transfer from personal loans and buy now pay later schemes as well. You can focus on paying off debt and improving your ratio and credit score.
4. Use interest-free instalment plans.
Some banks and credit card providers now offer interest-free repayments that are split into four instalments, much like a buy now pay later offer. Using instalment plans can help you balance out your ratio by knocking down debt systematically while avoiding interest fees.
5. Compare for savings.
One way to free up more cash to pay down debt is to compare utilities and insurance for better deals. There are many comparison sites that help you pit one plan against another, which can save hundreds of dollars each year for just a few minutes of your time.
Your debt-to-credit ratio can be an ally, not a foe
Owning your finances and being smart about debt empowers you to negotiate and save money on your home loan. It can boost your borrowing capacity, save you tens of thousands of dollars on your mortgage repayments and get you into a home faster.
More on reducing home loan repayments
How else can I lower my home loan repayments?
- Negotiate a lower interest rate with your lender. This is the most effective way to lower your repayments. You can do this by shopping around for a better deal or by asking your current lender to match the rates offered by other lenders.
- Refinance your loan. This means taking out a new loan with a different lender. This can be a good option if you can get a lower interest rate with a new lender. However, there are fees associated with refinancing, so you need to make sure that the savings you will make on your interest payments outweigh the costs of refinancing.
- Make extra repayments. Even if you can’t afford to make a big extra repayment, even a small amount, such as $1 a day, can help to reduce your interest payments and pay off your loan faster.
- Switch to an offset account. An offset account is linked to your home loan and your savings in the account are used to offset the interest on your loan. This can save you a significant amount of money on interest payments.
- Extend the term of your loan. This will reduce your monthly repayments, but you will pay more interest over the life of the loan.
Can I reduce my monthly repayments?
Yes, you can reduce your monthly repayments by making extra repayments. However, it is important to note that this will not reduce the amount of interest you pay over the life of the loan.
The only way to reduce the amount of interest you pay is to either negotiate a lower interest rate or to make extra repayments that will reduce the principal balance of your loan.
Does paying $1 a day reduce interest?
Yes, paying $1 a day will reduce the interest you pay on your home loan. However, the amount of interest you save will be small. To make a significant difference, you would need to make larger regular repayments.
Do home loan repayments decrease over time?
Yes, home loan repayments decrease over time. This is because the amount of interest you pay decreases as the principal balance of your loan decreases. The faster you pay off your loan, the less interest you will pay overall.
