- What is a credit card?
- How does the interest-free period work with credit cards?
- Does having a Credit Card affect getting a Mortgage?
- How do lenders calculate my Credit Card expenses?
1. What is a credit card?
A credit card is an unsecured credit facility that allows you to purchase items without paying cash up-front. This means that the bank will lend you the money by paying for it first and the borrower will have to pay it back at a later date.
Most credit card providers will give you up to a 55 day interest-free period to pay off what you borrow. If you do not pay off the full amount inside the interest-free period, the bank will then charge you interest on the balance you owe them.
2. How does the interest-free period work with credit cards?
There is a common misunderstanding that when the bank offers you a 55 day interest-free period, you have 55 days to pay for the money you borrowed for your purchase.
This is only true if you made a purchase on the first day of your statement period. This could be the first day of the calendar month or when you first took out the credit card. It is worthwhile checking when your statement cycle period starts so you can work out what your interest period is.
Let’s look at an example that will help you better understand how it works.
- Interest-Free period – 55 days
- Statement Cycle – 1st to the 30th day of the month
If you made a purchase from;
Day 1 – You will have 55 days interest-free
You made a purchase on the first day of your statement cycle and benefit from the full 55 days interest-free.
If you do not pay off your outstanding balance on time, the bank will forfeit your interest-free period and you will be liable to pay interest from day 1 until the closing balance is paid off in full.
Day 15 – You will have 40 days interest-free
You making a purchase in the middle of your credit card statement cycle so your true interest-free period is only 40 days and not 55 days. Again, if you do not pay off your outstanding balance on time, the bank will forfeit your interest-free period and you will be liable to pay interest from day 15 onward until the closing balance is paid off in full.
Day 30 – You will have 15 days interest-free
In this scenario, you will be making a purchase at the end of your credit card statement cycle so you true interest-free period like the previous example is only 25 days. It would be more beneficial for you to delay your purchase by one day so that your new purchase would fall at the beginning of your new statement cycle giving you the full 55 days interest-free period.
3. Does having a Credit Card affect getting my Home Loan Approval?
There is a misconception on how lenders view your credit card when it comes to working out how much you can borrow.
Most borrowers think that paying off their outstanding balance every month or not using the full credit card limit won’t affect how much they can borrow, however, this is not the case.
Here are some of the things you should know about your credit card and how it impacts your home loan approval:
Lenders look at your credit limit and not the outstanding balance you owe when applying for a home loan
When the lender assesses your home loan applications, the lender looks at your total credit card limit at the time of application. This is because lenders will take a conservative view and assumes that you will use up your full credit card limit regardless if you use it or not.
Having multiple credit cards may impair your home loan application.
Applying for several credit cards can be a huge red flag because some lenders still use a credit scoring system to determine your creditworthiness. Unbeknownst to a lot of borrowers, every time you apply for a credit card, there will be a credit inquiry noted on your credit report. Having too many credit inquiries (credit cards, personal loan or home loans) may lower your credit score which can hurt your home loan application.
Overdrawing on your credit limit
If you are always using your credit card where you go over your credit card limit, this may be viewed by the lender that you are unable to meet your required monthly repayment obligations. It pays to keep a close watch on this before submitting.
Doing a Balance Transfer or Applying for the reward point
There are benefits in applying for a balance transfer where there is zero interest on your outstanding balance for a specified period, typically anywhere between 6 – 12 months or if you were to be rewarded with frequent flyer points. However, if you were to keep applying regularly, this may reduce your credit score because of the credit inquires which inadvertently impact your home loan application.
4. How do lenders calculate my Credit Card expenses?
When working out your borrowing capacity, the lender will use your uncommitted funds which is how much you are left with after taking your monthly expenses into account.
Uncommitted Funds: Net Income – Total Expenses
The uncommitted funds will then be used to determine how much debt your income can support.
Different lenders will have a different approach when assessing your credit card expenses. As we previously noted, the lender will assess your total credit card limit and not the outstanding balance that you used. In other words, if you have a credit card limit of $10,000 but only use $2,000 every month, they will assess it based on the $10,000 limit.
Method 1 – Deeming Rate
Some lenders will apply a deeming rate to work out your monthly credit card expenses. This deeming rate ranges from 3% – 3.8%.
If you have a $10,000 limit and the lender uses a deeming rate of 3.8% then your monthly expenses are:
($10,000 x 3.8%): $380 per month
Method 2 – Applying Principal and interest Repayment over a 3-year period
This is where the lender will apply a high interest rate (cash in advance rate of 20%) and assumes you will be paying it off in 3 years.
If you have a $10,000 limit and the lender uses the principal and interest method, then your monthly expenses are $371 per month.
This monthly credit card expenses are usually in addition to your declared living expenses which artificially increases your monthly commitments while reducing your uncommitted funds. This is true even if you don’t use your credit cards at all.