A rough rule of thumb among lenders is that every $500 you have in debt, including credit cards, can reduce the size of the mortgage you’ll qualify for by $80,000 to $100,000.bernie_moto/iStockPhoto / Getty Images
When it comes to applying for a mortgage, borrowers tend to be laser-focused on interest rates, the down payment they’ve cobbled together and their credit score.
But there’s another crucial piece of the qualification puzzle that can have a big impact on how much mortgage you’ll get: your existing debts.
When considering an applicant, mortgage lenders take a holistic look at their financial picture. Yes, the money you’ve saved up front is an important factor, but they want to know whether you can realistically carry your mortgage – a.k.a., whether you have the cash flow to consistently make your monthly payments.
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If you have large debt obligations – such as car payments, credit card balances or other types of loans – they can shrink the amount of mortgage you’ll qualify for, even if you have a healthy income.
A rough rule of thumb among lenders is that every $500 you have in debt can reduce the size of the mortgage you’ll qualify for by $80,000 to $100,000 – although this will vary widely based on a borrower’s specific circumstances.
Still, that’s a daunting number – and it packs a significant impact.
To further illustrate, let’s crunch a theoretical deal using Ratehub’s mortgage affordability calculator. We’ll assume two borrowers applying together have a combined household income of $150,000, a down payment of $45,000 and can get a competitive five-year fixed interest rate of 3.84 per cent.
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According to the calculator, they would qualify for a mortgage of $674,807. Now, let’s tack on both a $1,000 monthly car payment, and $1,000 credit card payment. The qualification amount is now reduced to $486,920. That’s a significant reduction of $187,887 – one that can determine the type of home they can afford.
Readers looking for a precise indication of how their debt will affect their qualification can look at the two ratios that lenders use in the qualification process: gross debt service ratio (GDS) and total debt service ratio (TDS).
The GDS assesses the portion of your regular income that will be put toward your continuing home costs. This includes your mortgage payments and also factors in property tax and your heating bill. If you’re purchasing a condo, 50 per cent of your condo fees will be worked into this equation.
Your lender will then divide this monthly total by your gross monthly income. The ideal GDS ratio is 32 per cent or below, though some lenders will accept up to 39 per cent if you’ve got a great credit score.
The TDS, meanwhile, takes all of your debts into account. Your lender will start with the same GDS calculation, and add in any other monthly payments you have. This ratio should come in at 40 per cent or less, with wiggle room up to 44 per cent in some cases.
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These ratios give lenders a clear look into your ability to repay your mortgage and are pivotal in the qualification process. If you’re within the desired range, you’re generally in good shape.
This is why anyone planning to buy a home should focus on aggressively repaying their debt before putting in a mortgage application. Think of it as a prepurchase tune up, alongside checking your credit report, saving your down payment and finding a real estate agent.
Homeowners slated to renew their mortgage term aren’t exempt either. Most often, lenders don’t feel the need to requalify existing borrowers, but they will if your debt obligations have significantly changed. If you’re switching to a new lender or refinancing at renewal time, your debts will undergo the usual scrutiny.
And by all means – avoid doing anything that will significantly increase your debt load before your mortgage approval is finalized. There’s been many a borrower who’ve seen their mortgage fall through because they bought a new car before the papers were signed and sealed.
What do you want to know about mortgages?
Do you have a mortgage question for our expert? Is a variable or fixed rate the best option? Does it make financial sense to refinance? Is it better to consult your bank or go to a mortgage broker?
Submit your questions below and Ratehub's Penelope Graham could answer it in an upcoming column.
Penelope Graham is the head of content at Ratehub.ca
