For many of us, our instinct is to feel a sense of guilt over having some debt. However, the majority of the UK’s population is in the same position. Having to borrow money throughout our lives is the norm for many and can benefit us if we handle it correctly. For example, student loans, car finance, or small credit card purchases can help us improve our credit score and help lenders paint a picture of our financial situation during the mortgage application process.
It’s once it gets out of hand, which is when problems start to arise. One missed credit card payment can drastically affect your credit score for up to six years, its impact reducing with every year. Miss additional repayment deadlines and you’re in more trouble, potentially reducing your ability to get a mortgage for another year or two and setting yourself up for worse mortgage deals.
When attempting to manage your debt before getting your foot on the property ladder, just remember - it’s not about paying off every penny you owe. Instead, your focus should be around tackling ‘bad’ debt over ‘good’ debt (yes, there is a difference), and looking at your credit spread in order to appear more creditworthy in the eyes of the lender.
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Good debt vs. Bad debt?
A good starting point when tackling your debt is to look at the ‘spread’ of your debt - how much of it is ‘good’ and how much of it is ‘bad - yes, you heard that right. Not all debt is the same, in fact, the right type of debt is necessary for you to build a credit profile and be seen as more creditworthy in the eyes of the lender.
Things such as your student loan, car finance, or small credit card purchases can all be seen as ‘good debt’ , and you are unlikely to get penalised for it during your mortgage application process as long as you make your repayments on time. ‘Good debt’ is what helps you improve your credit score and create a clear and reliable credit history, and will help you when applying for a mortgage further down the line, as lenders will have a clear indication that you are capable of making regular repayments.
Of course, these forms of debt are only good if they contribute to your repayment history - not lack thereof. If you miss some of the payments, your credit score will drop, and these records will be held on your credit profile for years to come.
‘Bad debt’ can be described as any form of debt that affects your credit score negatively and leaves a lasting negative impact on your credit report. This includes payday loans loans, which even if paid off on time can be looked down on by lenders.
Debt to Income ratio
Your debt-to-income ratio does not directly affect your credit score but is calculated separately and helps to paint an overall picture of your creditworthiness. It demonstrates the balance between your debt and your income - for example, if your DTI is 15%, it means that 15% of your salary is dedicated to repaying your debts every month. Obviously, the lower your DTI, the better, however, the rule of thumb is that you should aim to keep it below 40%.
Anything above that will appear as an extra risk in the eyes of the lender, as it reduces your affordability. If your DTI is, let’s say, 50% - that means that half of your monthly wage is dedicated to repaying debts. That’s before paying your rent, bills or car insurance meaning your actual disposable income is much lesser than what it appears to be on your payslip.
Best ways to get your debt under control
Preparing for a mortgage is a process, and it can sometimes take months to optimise your credit score and financial profile to be able to start applying for a mortgage with confidence. This applies particularly to those who may have a little bit too much debt under their belt or may need to work on rebuilding their credit score. As much as your debt repayment journey may seem intimidating, once you get started, it’s guaranteed to just get easier and easier. We have outlined our best tips on how to get your debt under control below:
1. List everything you owe
Many people are stuck on autopilot and so overwhelmed by their debt that they may not want to face exactly how much they owe and to whom they owe it. The first step to regaining control over your debt is to face your fears and figure out exactly what you’re standing on. This can only be done by carefully writing out how much money you owe, who you owe it to, how much interest you’re currently paying as well as any additional charges you have to cover if you have not been making your debt repayments on time.
2. Consider consolidating your loans
Debt consolidation is when you take out credit, such as a loan, to pay off all of your other debt sources. As much as this does not decrease the amount of debt you have, it allows you to pay it off consistently in one lump sum instead of having to stay on top of multiple different debt sources and their varying interest rates.
This can make it much easier for you to manage your debt and can also reduce the amount you pay, as you will only be charged interest on the loan you take out.
3. Look into balance transfer credit cards
If you’re mostly dealing with credit card debt, you can look into transferring your debt onto a different credit card where you may be offered an interest-free period - reducing your monthly payments and saving you money in the long run. With the average interest rate in the UK sitting around 22%, you can save a substantial amount by not having to pay that on top of your regular repayments every month, giving you an opportunity to also repay your debt quicker.
4. Figure out a savings plan
When trying to pay off debt, you should aim to focus your budget on making repayments whilst trying to cut down on other unnecessary costs. This applies particularly if you are paying interest on your debt - in which case, the longer you take to pay it off, the more you end up paying. Create a strict savings plan and budget in order to cut down on all other unnecessary purchases and dedicate every penny you save to paying your debt off in larger chunks. The process may be tedious and unpleasant, but it will help you reach your goal of being debt-free faster.
5. Get help if you need it
Trying to tackle your debt can be overwhelming, particularly if you’re dealing with different credit sources. If you are struggling to figure out how to best tackle your debt or don’t know how to do so efficiently, don’t hesitate to get help. The national debt helpline is available to UK citizens and provides free personalised advice on how to regain control over your finances.