How a $200 lay-by purchase can sink a mortgage

OPINION: In the past few years, a number of companies have set up online lay-by systems. These systems are available at most major online shopping sites and, on the face of it, seem quite reasonable.

Typically this type of payment arrangement is for a lower-priced product, often under $200. The terms are often:

• Spread over four fortnightly payments;

• Interest-free; and

• Don’t even involve a credit report check.

While it is best practice to have cash available for anything you purchase, these certainly are at the lower end of harmless debt.

Issues crop up when you regularly use this type of delayed-payment arrangement and then apply for a mortgage. Although this debt is short-term (eight weeks typically), the bank must view them as an on-going debt. In other words, they must assume that you have this facility available and intend to continue to use it. For example, let’s say you have three lay-by debts totalling $200 per month. The bank removes that $200 from your available income when they calculate your mortgage affordability. This reduces your ability to borrow on a mortgage by approximately $25,000.

Secondly, a lot of people who have these payment arrangements pay for them on their credit card. Even if they are diligent about paying off their credit card debt each month, just having a limit reduces your ability to borrow a mortgage. A $10,000 credit card limit reduces your mortgage borrowing by about $46,000.

You can see the problem here. An interest-free lay-by arrangement of only $200 per month paid on a credit card that is paid off every month doesn’t seem like a terrible position. There was no interest paid throughout the whole transaction. But just having the debts there has lowered your borrowing ability by approximately $71,000.

Mortgage applicants are often frustrated with this, especially if there is only one or two payments left on the lay-by arrangement. Can’t the bank just ignore them? The payment will be finished by the time the mortgage has begun, after all.

Unfortunately, it’s not a question of your financial position and more a view of your financial character. From the bank’s point of view, you are willing to utilise this type of debt so are highly likely to do so again in the future.

Micro-finance debts aren’t inherently bad. Imagine if you were unemployed and knew that if you could buy a lawnmower for $400, you could earn at least $400 per fortnight mowing your neighbours’ lawns. Spread the purchase of your mower over four fortnightly payments and you are, in theory, in a better financial position. You’re paying $100 per fortnight for the mower debt and earning $400 per fortnight in income.

But if these debts are used for luxury purchases, particularly when you are applying for a mortgage and need to show how frugal you are with your spending, they can significantly affect your ability to purchase your home or next investment property.

- Rupert Gough is the founder and CEO of Mortgage Lab and author of The Successful First Home Buyer.