Is That Car Loan or Personal Debt Preventing You from Making Your Next Property Purchase?

When you’re working towards buying your dream home or getting that investment property, debts like car loans, personal loans or anything else you still owe can really cut into how much a lender is willing to offer you.

Even if you’ve already made significant progress in paying them down.

In today’s blog we cover:

Car and Personal Loans: How Short Loan Terms and High Repayments Destroy Your Borrowing Capacity
A Real-World Example: How Closing a Loan Can Boost Your Borrowing Power
Should You Close a Loan to Boost Borrowing Power?
Assessing Your Financial Strategy Before Closing Loans
A Key Tip

Car and Personal Loans: How Short Loan Terms and High Repayments Destroy Your Borrowing Capacity

Here’s a scenario we see all the time!

Someone takes out a $50,000 car loan, makes regular repayments and now owes around $30,000.

Understandably, they wonder if paying an extra $10,000 off the balance will help improve their borrowing capacity.

Unfortunately, it won’t.

Unlike credit cards, lenders assess personal and car loans based on your monthly repayment amount, not the remaining balance.

Just like they do for your home loan.

So even if you pay a lump sum to reduce the loan, your monthly repayment usually stays the same and that’s what the lender continues to factor in.

For example, let’s say you have:

$30,000 remaining on a car loan
Monthly repayments of $950

Even if you pay $10,000 off the balance, that $950 repayment doesn’t change.

As far as the bank is concerned, you’re still committed to that full monthly amount and they’ll count that against how much you can borrow.

Only by closing the loan, can you eliminate the impact to your borrowing power.

This applies to personal loans, car loans, mortgages and even HECS/HELP debt.

In fact, anything with regular, ongoing repayments.

A Real-World Example: How Closing a Loan Can Boost Your Borrowing Power

Let’s say you’re a single borrower earning $150,000 a year, and you have a $30,000 car loan with monthly repayments of $950.

Now, imagine you decide to pay out that loan in full using your savings.

By removing that $950 monthly repayment from your financial commitments, your borrowing capacity could increase by around $170,000.

Improving borrowing capacity by paying out car loan - single applicant

For couples earning a combined $300,000 per year, closing that same loan could improve borrowing capacity by $190,000.

Closing a loan in full can be a powerful strategy if you have the funds, potentially unlocking access to better properties, more desirable locations, or a higher-quality home than you’d otherwise qualify for.

Improving borrowing capacity by paying out car loan - couples

Should You Close a Loan to Boost Borrowing Power?

Paying off a loan can give your borrowing capacity a meaningful boost, but it’s not always the right move.

Before rushing to close debts, it’s important to step back and consider how the decision impacts your overall financial position, especially your savings buffer.

Let’s say you have $50,000 in savings and you’re considering using $30,000 to pay out a car loan.

Yes, it could improve your borrowing power, but it would leave you with just $20,000 for settlement costs and post-purchase expenses, which is unlikely to be enough to complete settlement and have a solid buffer after you purchase.

However, if you’ve saved $100,000 and are only looking to clear $10,000 in debt, that decision might feel more comfortable and justifiable.

Assessing Your Financial Strategy Before Closing Loans

Ultimately, this kind of mortgage strategy needs to be assessed case by case, taking into account:

Your target purchase price,
Your planned loan-to-value ratio (LVR),
The size of the debt you’re paying off,
The amount of borrowing power gained,
The impact on your savings buffer
Your risk appetite and financial goals

For some buyers, running a little leaner for a short period might be worthwhile if it means unlocking a better property or gaining access to equity for renovations or investing.

For others, maintaining liquidity might be more valuable than stretching for extra borrowing capacity.

The key is to work through these decisions with your strategic mortgage broker.

They will help you weigh up the trade-offs, run the numbers and make a confident, informed choice that fits your strategy.

A Key Tip

“If you’re planning to buy property soon, it’s usually best to avoid taking on new debts like a car loan or credit card before you’ve locked in the purchase.”

Even a seemingly small new liability can reduce your borrowing power more than expected.