For many people, applying for a mortgage is both a familiar and daunting process. While a crucial step in becoming a homeowner for many, the prospect of taking on long-term debt can seem like an overwhelming experience.
At present, there are over 11.1 million mortgages in the UK, while the sector itself is estimated to be worth more than £1.3 trillion. What’s more, a recent survey by KnowYourMoney.co.uk discovered that 24% of Britons have mortgage debts. In fact, this is the second most common form of debt behind credit card debt (35%).
Buying a home is a big step in anyone’s life, and for many, a mortgage will also be the largest single debt they take on in their lifetime. So, for those looking to either jump on the property ladder, or add to their existing real estate portfolio, it’s crucial to take measures to ensure any debt accrued is responsibly managed.
Why planning is so important
The long-term nature of mortgage repayments can be a significant financial burden to bear, particularly for those who are not on top of their finances.
Unfortunately, poor preparation can lead to an inability to keep up with repayments – data from UK Finance suggests that in the first quarter of 2019, there were 76,580 mortgages in arrears of 2.5% or more. Meanwhile, approximately 61 mortgage possession claims are made every day.
KnowYourMoney.co.uk’s research shed some light on bad practices employed by some Britons when it comes to managing personal finances; namely, the lack of long-term planning.
For example, two thirds (67%) of those in debt admit to having no money in savings stored away to enable them to pay off debt if required. And men (73%) are more likely than women (62%) to lack a financial safety net.
Even more concerning, 29% of people do not feel in control of their debt and have no clear plan of how they will pay it off. So while it might seem obvious, understanding one’s own financial situation is vital in ensuring debt does not become unmanageable.
Do you know your DTI ratio?
Do you know what your debt-to-income (DTI) ratio is? For those who are shaking – or scratching – their head, you’re not alone. According to KnowYourMoney.co.uk’s research, 39% of UK adults do not understand what the phrase DTI ratio means, while 44% do not know what their ratio is.
In short, a DTI ratio offers an indication of how much debt a person has in relation to their earnings. The way this is calculated is fairly straightforward: a person’s total recurring monthly debt is divided by their gross monthly income.
Though a simple tool, your DTI ratio is extremely valuable when it comes to understanding how much debt you can responsibly handle, and in turn, what mortgage options are best suited to your individual needs and circumstances.
Even better, you don’t have to work this out yourself, as there are a number of helpful online DTI calculators that are freely available.
Good debt versus bad debt – and why it’s important
One of the most important considerations when taking out a mortgage is also recognising the difference between good debt and bad debt.
On the one hand, good debt is an investment that is manageable, and will grow in value or generate long-term income. Student loans are often cited as a form of good debt, as are mortgages, which enable people to secure a property that could offer financial stability and long-term returns in the form of capital growth. Of course, this is dependant on the mortgage being managed responsibly.
Bad debts, meanwhile, are those that cannot realistically be repaid or provide no value. A common example is when a borrower takes on debt to pay off other debts.
To avoid falling into financial difficulties, borrowers are encouraged to examine the limits of their own personal finances through helpful tools, such as the DTI ratio, and only accrue good forms of debt. Whenever possible, borrowers should also set aside savings to help make repayments in case of cash flow issues in the future.
Through preparation and careful management, borrowers can build a successful financial strategy and accrue mortgage debt in a safe and responsible manner.
John Ellmore is the director of KnowYourMoney.co.uk, an independent financial comparison website that was launched in 2004. Run by a dedicated team, Know Your Money’s goal is to provide clear, accurate and transparent comparisons for a wide range of financial products.
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