As mortgage specialists, we have seen people go to a bank directly to apply for a loan only to get declined. After fact finding, we notice they have something like $40,000 limits on their credit cards. Yet they never used more than $5000.

A simple reduction in credit limit before approaching lenders solves the problem.

That's Because Banks Tend to Do This

If you have good payment history, the bank will offer to increase the limit on your credit card even if you don’t need it. They assume the higher the limit you have on the card, the more you will spend and the more interest they will make from you. Very few people realise the impact of an increased credit limit on a home loan application  and even some people think this is a sign of good credit history to qualify for accessing such amount.

Well most of the time they are wrong. Before a lender considers you, they take into account factors which include your credit card’s limit, capacity to repay a loan, financial risk, collateral and existing assets. Higher unused credit card limits may make repaying loans difficult. That's because they don't consider monthly loan repayments, but total loan repayment if the credit card is maxed out. 

What happens behind the scenes is that when the lender calculates your borrowing capacity, adding a margin 3% of your credit limit as the financial commitment on top of your living expenses even if you pay off your credit card every month.

The higher the threshold, the more expenses will be allocated therefore less income capacity for servicing new debt. The higher total credit card limit you have - the more impact it will have on your borrowing power. Higher than needed credit card limits not only affect your borrowing power but also have dangerous fraud potential.

The Fix

• If you have more than one credit card, consolidate credit card debts and cancel cards that are no longer needed. This helps reduce monthly repayments and opens up funds for other repayments
• Reduce the limit on your cards to the lowest possible amount for your situation.
• Once your credit card is paid off, consider setting up direct debit to make sure your credit card outstanding balance is paid off each month from your income account.

Once you have freed up your ‘financial commitment’, lenders will use this and add all other net income to your servicing calculation which in the long run is walking towards approval.

Disclaimer: The content in this article are provided for general situation purpose only. To the extent that any such information, opinions, views and recommendations constitute advice, they do not take into account any person’s particular financial situation or goals and, accordingly, do not constitute personalised financial advice. We therefore recommend that you seek advice from your adviser before taking any action.