Debt or deposit?
It’s a common dilemma facing many aspiring home buyers. You’re trying to put as much money as you can towards a deposit for that much revered first purchase, but what about those bothersome debts that just won’t seem to go away?
Perhaps you took out a loan to buy a car. Or maybe you’re still paying off that trip through Eastern Europe you took last year. Whatever it is, it bears the question, is that where you should be allocating of all your hard-earned cash? Or should you be putting all of your money towards your deposit for a house?
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Ultimately, this is a personal decision and will depend on your own personal circumstances. But when it comes to the fundamentals of good money management, one key rule of thumb to always remember is that debts should be paid down as quickly as possible, because of the interest costs they accrue.
Moreover, the interest costs of personal debts such as credit cards, car loans and personal loans tend to be quite high and can easily offset any interest you might earn in a savings account.
For example, a personal loan might attract an interest rate of 14 per cent, while a savings account might earn you just six per cent in interest – if you’re lucky.
Just doing the interest calculations on a personal loan paints a useful picture. On a $15,000 personal loan at 14 per cent interest on a five year loan term you’d be looking at total interest expenses of $5,941.43 (based on minimum repayments) – that’s a big chunk of cash which could certainly go a long way towards your savings goals.
Paying off those expensive debts first will help you avoid such interest charges and enable you to work on saving your deposit sooner.
By reducing and eliminating other debts, you’ll also increase the amount you’re eligible to borrow, with lenders’ serviceability assessments influenced largely by borrowers’ existing debt obligations – as well as the propensity to take on further debt. In other words, even if your credit card is paid in full, a $30,000 limit for instance is going to hit your loan eligibility, because you could, in theory, rack up another $30,000 in debt very easily.
While it may seem frustrating to put your savings goals on hold, in the end you’ll be in a much sounder financial position if you address your debts first.
The key is to work on paying your debts down as quickly as possible. And do your absolute best to avoid missing payments. One or two defaults on your credit history can really make it that much more difficult to secure a home loan.
