Personal loans or credit cards? What to pay off first

Many of FHBA’s first home buyer clients have some form of credit card or personal/car loan debt. One of the most frequently asked questions is which type of debt should be paid off first.

WHAT IS THE DIFFERENCE?

Credit cards are financial products that allow customers to use the funds up to a certain limit at their own leisure. In comparison, personal/car loans are financial lending products that allow customers to borrow up to a certain amount with periodic repayments over the fixed life of the loan.

HOW IS A PERSONAL LOAN LIABILITY CALCULATED?

When lenders determine your maximum borrowing capacity the minimum repayments on the personal/car loan contract will be used. For example, if you have a car loan for $10,000 over a 5 year period with repayments of $250 per month.

In the above scenario, lenders will use the minimum repayments of the $250 per month as an additional expense beyond the minimum monthly living expenses.

HOW IS A CREDIT CARD LIABILITY CALCULATED?

When lenders determine your maximum borrowing capacity, the credit card limit you have placed is used, i.e. the higher the limit the less your home loan borrowing capacity will be. For example, if you have a credit card limit of $10,000 regardless of the amount you have used, the lenders will use approximately 3.80% per month as a liability.

Therefore, in this example,  the lenders will use $380 per month as an additional expense beyond the minimum monthly living expenses.

WHICH LIABILITY SHOULD I PAY OFF FIRST?

As per the scenarios above, it is a good idea to either pay off the credit card in full or pay off a portion and reduce the limit before making any extra repayments on the personal loan. this is as a result of the credit cards reducing your borrowing capacity by an amount more than the personal loans would.

However, factors such as the interest rate on personal loans in comparison to credit card interest rates should also be taken into account, as some may have interest free balance transfer credit cards.

IS IT A GOOD IDEA TO CONSOLIDATE CREDIT CARDS INTO A PERSONAL LOAN?

At FHBA, our team of experts can also help you get first home loan ready before you embark on your first home buying journey. If you are looking to buy your first home in the future but have some credit cards and/or personal/car loan debt, our coaches can help you decide whether you should consolidate your debts, which will help grow your chances of getting the maximum borrowing capacity for your first home.

Click here to chat to a FHBA Coach, to determine which liability you should pay off first. 

Written By,

First Home Buyers Australia

FHBA
FHBA