Mortgage Basics

Understanding the Impact of Different Debts on the Mortgage Approval Process

Understanding the Impact of Different Debts on the Mortgage Approval Process
Written by
  • Ashley Howard
| 3 November 2023
Reviewed, 3 November 2023
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    When buying a home or property in Canada, your current debts play a significant role in the mortgage approval process. Lenders carefully assess the debts you carry to determine your eligibility for a mortgage. 

    Understanding how different types of debt can impact your mortgage application is essential for securing the financing you need. In this guide, we will explore different types of debts that could affect and influence your mortgage approval and eligibility.

    Key Takeaways

    • Lenders consider your entire financial situation, including your credit score and income, when evaluating your mortgage application. 
    • Lenders will use the monthly payment or the total balance to determine a monthly amount when factoring their carrying costs into your debt service ratios. 
    • Keeping your gross debt service (GDS) and total debt service (TDS) ratios at or below the recommended limits will improve your chances of being approved for a mortgage. 

    Demystifying the Relationship Between Debt and Mortgage Approval

    There are a few factors affecting mortgage approval as much as your credit capacity: the ability for you to manage repayments. The top characteristics of your financial situation a lender will consider are your credit score, debt-to-income ratios, and income to determine your ability to repay a mortgage. 

    Your debt impact on your mortgage eligibility depends on how well you can manage timely repayments. Your ability to manage your debts is evident through your credit score. A higher credit score makes you less risky to lenders as it indicates you can manage debt effectively. Lenders will closely examine your credit history and current debt obligations to assess your ability to handle additional debt, such as a mortgage. 

    For mortgage approvals, one of the most important factors lenders consider is your debt-to-income ratio. Lenders use two ratios: gross debt service (GDS), which is the maximum shelter costs you can afford each month, and total debt service (TDS), which is the maximum total debt repayments you can afford each month.

    A lender may reconsider your ability to handle mortgage payments if your ratios, the percentage of your debts compared to your income, need to be lower. 

    How Different Types of Debt Can Influence Your Mortgage Application

    Mortgage lenders will weigh certain debts by using either the monthly payment or a portion of the entire balance to determine a monthly payment amount when factoring them into your debt service ratios. 

    Mortgage eligibility is affected with student loans, as the entire balance will be used to calculate a portion that will be factored into your monthly debt load. A large student loan payment can increase your debt-to-income ratio and make it harder to qualify for a mortgage. 

    Mortgage approval while carrying credit card debt can be tricky as your balances fluctuate monthly. If you have high credit utilization (using more than 30% of your available limits), your credit score could be negatively impacted. Lenders will use the entire balance of credit card debt to calculate an amount they believe should be paid monthly. 

    How much you actually repay is not factored into the monthly calculation. However, if you’re planning on paying off the balance to move forward with your mortgage approval, then let your mortgage expert know so they avoid considering this as part of your debt service ratios.

    The impact of car loans on mortgage approvals can be more significant depending on your income and debt levels. Since car loans have fixed payments, lenders will use the monthly fixed payment amount when calculating your debt service ratios. A large car loan payment can significantly increase your debt-to-income ratio and make it harder to qualify for a mortgage. 

    Unravelling the Effect of Credit Card Debt on Your Mortgage Approval

    Your credit card debt’s effect on your mortgage eligibility will depend on how much debt you have and how much credit you utilize as a percentage compared to your limits.

    Lenders will consider the entire balance of your credit card debt and calculate a monthly payment amount based on a percentage they believe you should be paying to clear the debt. 

    CMHC requires that percentage to be no less than 3% of the outstanding balance. The higher your credit card balances are, the more they will work against your mortgage qualifying amount and impact your debt service ratios. 

    If you are preparing to purchase a home, you must effectively manage credit card balances for mortgage approval. This means reducing credit card debt before mortgage application to ensure you utilize 30% or less of your revolving credit limits, have a history of making payments on time, and pay off more than the minimum amounts each month to improve your credit score. 

    More importantly, paying off higher-interest credit card debt frees up more of your money toward your downpayment and closing costs.

    Student Loans and Your Mortgage: Navigating the Path to Homeownership

    Student loan debt impacts your debt service ratio and credit score. Student loans are reportable to the major credit bureaus in the same way that other types of loans are. 

    Your student debt impact on mortgage eligibility will depend on how much you owe compared to your income. While not in repayment, lenders will consider 1% of the entire balance of your student loans as the monthly payment. 

    Once you’re in repayment, the actual reported monthly payment on your credit bureau will be considered when evaluating your monthly debt load and debt-to-income ratios. 

    You must be effectively managing student loans for a successful mortgage application. Make consistent payments to maintain a healthy credit score and pay down as much student debt as you can comfortably manage to increase your mortgage affordability.  

    Car Loans and Mortgage Approval: How Auto Financing Affects Your Home Loan Goals

    The impact of car loan or lease payments on mortgage approval can be significant, depending on how much you pay each month. Lenders will consider the monthly payment of your car loan when assessing your debt-to-income ratios. 

    When it comes to auto loans affecting your mortgage eligibility, it’s important to avoid applying for a car loan right before your mortgage. Your credit can be negatively affected due to a hard credit inquiry, causing your credit score to drop temporarily. 

    If you already have a car loan, you can increase your chances of approval and improve mortgage affordability by reducing your car loan balance, making it easier to qualify on your mortgage application.

    Mastering the Art of Debt-to-Income Ratio for Easy Mortgage Approval

    Debt-to-income (DTI) ratios are an essential factor in the mortgage approval process. Lenders use GDS and TDS ratios to assess your ability to manage monthly mortgage payments based on income and existing debt obligations. Calculating debt-to-income ratios involves calculating both GDS and TDS ratios.

    You can calculate GDS by adding the expected monthly costs for the home you wish to purchase and dividing that by your monthly pre-tax or gross income. Your TDS is calculated by adding your GDS calculation with all other debts (car loans, student loans, credit card debt, child/spousal support payments, etc.) and dividing that by your pre-tax or gross income. 

    The recommended DTI for mortgage approval is: 

    • GDS no more than 32% for uninsured mortgages and 39% for insured mortgages 
    • TDS no more than 40% for uninsured mortgages and 44% for insured mortgages 

    It pays to manage your debts, as some lenders may qualify on GDS of 35% and TDS of 42% for uninsured mortgage transactions if you have an excellent credit score.

    Frequently Asked Questions

    Should I pay off my car loan before applying for a mortgage?

    Paying off your car loan before applying for a mortgage can improve your chances of approval. Lenders factor in the monthly payments of your car loan when assessing your debt-to-income ratio. By eliminating your car loan, you will increase your mortgage affordability and chances of approval.

    Should I reduce my student loan repayments before applying for a mortgage?

    If you are in repayment, you may be able to reach out to your lender or the government’s student loan centre and inquire about reducing your student loan repayments to the minimum amount. This should be done a few months before applying for a mortgage. This will reduce your total debt servicing ratios for qualification. 

    Once your mortgage is closed and funded, you can increase your payments again without impacting your already funded mortgage. It’s important to consider your total debts against your downpayment and ask yourself, will I have a positive net worth after my mortgage funds?

    How are other types of debt treated on my mortgage application?

    Leases and loans are considered based on the monthly payment on your credit bureau. Student lines of credit are considered as 1% of their outstanding balance. Other lines of credit are based on the limit and are either 3% of the balance (if the limit is under $50,000) or amortized over 25 years at the Bank of Canada (BoC) benchmark rate (if the limit is over $50,000). The BoC Benchmark rate currently stands at 5.25%.

    How does spousal or child support affect my mortgage eligibility?

    Spousal and child support payments will affect your debt service ratios and qualifying amount. These payments are considered based on 100% of the monthly payment. 

    Final Thoughts 

    Understanding the relationship between the different types of debt and the mortgage approval process is crucial for prospective homebuyers. By managing your debts responsibly, reducing high-interest balances, and keeping your debt-to-income ratio within an acceptable range, you can improve your chances of mortgage approval. 

    If you’re considering buying a home, it’s always helpful to consult with a reputable and knowledgeable mortgage expert. They can guide you through the mortgage approval process, answer your debt-related questions, and help you find the best lending solution for your needs.