How Your Debt Affects Mortgage Approval
There are several factors a lender will consider when reviewing your mortgage application. Your interest rate and even your approval are largely dependent on the debt you’ve already accumulated throughout your life. For some, this can translate to avoiding debt at all costs, but the solution isn’t that cut and dry. We live in a country where nearly 80 million credit cards have been issued. To put that into perspective, Canada only has a population of 38 million people. This doesn’t even take into account different types of debt like CRA debt, personal loans, and overdue bills. In this week’s article, we are going to explore exactly how your debt impacts your ability to get a mortgage and how you can use it to your advantage.
Painting a Picture of Your Financial Health
Lenders are in the business of levying risk. The higher the chance someone defaults on their mortgage, the less likely they are to approve the loan. Similar to a job interview, assessing risk means looking into a person’s current situation as well as their history.
- Credit History. Checking out your credit history is a lot like contacting references. This gives the lender a good idea of how you’ve handled finances in the past so that they can make a fairly accurate prediction of how you’ll handle this new debt. Do you have a habit of making your payments in full and on time? What different types of debt have you managed? Not having any credit history is like not having any experience on your resume. Sure, there aren’t any apparent issues, but the lender has no idea how you may handle your mortgage. To them, that’s not worth the risk.
- Credit Limit & Utilization. Aside from just looking at your past experience, lenders are particularly interested in how much you are using your credit. Let’s take a look at two examples of credit card debt. In Scenario A, you have used $6,000 on a card with a limit of $6,500. In Scenario B, you have used $6,000 on a card with a limit of $10,000. A lender will not view these two scenarios the same. They will look more favourably on Scenario B because you still have $4,000 remaining on your card that is untouched. This tells them that you aren’t relying on maxed-out cards to stay afloat and can comfortably stay below your limit.
- Debt to Income Ratio. Finally, a lender will take into account how much debt you are currently carrying and compare it against how much money you are making. They will then determine whether they feel your finances could take the extra impact of mortgage payments and everything else that comes with owning a home. They take all your expenses and divide those by your gross annual income to get your gross debt service ratio, or GDS. In Canada, the minimum GDS to be applicable for CMHC insurance is 39%.
Creating a Healthy Relationship with Debt
So what can you do to convince lenders that you can handle a mortgage? Well, we’ve already touched on the fact that getting rid of every conceivable form of debt is unrealistic and unhelpful. What prospective homeowners need to focus on, then, is developing healthy debt. This means managing your credit intentionally. Make all your payments on time and more than the minimum amount. Curb any frivolous spending so that you are maintaining a reasonable credit utilization ratio. Some experts suggest keeping your usage around 30% of your credit limit, but do what is realistic for you. If you have a credit limit of $5,000, 30% would look like keeping the balance near to $1500.
When you do get the opportunity to lock in that mortgage you’ve been working so hard to get, that debt will be considered “good” as well and further improve your financial health. If you’re looking to access the best possible rates and conditions for your situation, consider working with a mortgage broker to help set you up with the perfect lender for you. Our specialists at Source Mortgage are professional, friendly, and can’t wait to meet with you! Contact us today to get started.