You might have heard the myth that you have to have zero debt in order to buy a home. The truth is, it’s the payment of your debt that is the focus. In the mortgage world, it’s all bad debt. Anything that has a payment associated with it works against you from the lender’s perspective. So let’s look at how these payments affect your mortgage deal.
Line of Credit
Unsecured debt is actually calculated at a payment of 3% of the balance and not your minimum monthly payment. If you have a $10K line of credit at 8% interest, you might only have a monthly interest-only payment of $66.67. However, the lender calculates your payment at $300/month (3% of $10K). This is an obvious example of a significant debt payment that will absolutely affect your buying power.
Keep in mind that there’s a difference between a credit line and a home equity line of credit. You (typically) can’t use an unsecured line of credit for your down payment. You can use a secured line of credit as a down payment on an additional property but the point here is, on a mortgage application, they’re both factored in differently.
Credit Card
Credit card debt is also calculated at a payment of 3% of the balance and not your minimum monthly payment. We’ve seen examples where there might be a credit card balance of just over $22K with a monthly payment of $440 (i.e. the minimum payment on the balance owing). The lender, however, will calculate the payment at 3% of the total balance which translates to a monthly payment of roughly $670\. This is another example of a significant difference in debt payment that will definitely impact your buying power.
Expenses
Expenses are an important part of your ongoing budget. The majority of expenses don’t come into play on your mortgage application. We only account for principal interest, property taxes, utilities, and a portion of condo fees (if applicable). The rest of your budget doesn’t affect your mortgage approval but will, in reality, affect your ability to pay for that mortgage. Although the bank doesn’t care about your expenses, you certainly do.
Car Payments
Having a car may be necessary for most of us but it’s also the single largest deal breaker in mortgage applications. Depreciation aside, it’s simply a large amount of money that’s borrowed over a relatively short amount of time which causes a large payment. We had a set of clients (with a combined household income of $155K) who finalized an offer of $740K for a new home purchase with a $100K down payment (plus additional closing costs beyond that).
With their down payment, income, credit, etc. the deal worked perfectly. Then they called me asking about buying a new car before they closed on the new home. The payment on the new car was going to be $1,100/month — which is a lot but not uncommon today. Before the car payment, their ratios were 35 and 40 (the ratios can’t be higher than 39 and 44 and represent your income relative to the cost of the home plus outstanding debt payments).
Once the car payment was factored in, the ratios jumped to 35 and 48 meaning the debt portion of the calculation was too high to qualify for the mortgage. The solution here was one of three things:
- Don’t buy the car
- Make more money (to the tune of $15K per year in this case)
- Add $50K more to the $100K down payment
To summarize… cars kill deals!
Utility Bills
A credit history is one of the first three things we look at when completing a mortgage application. The rule of thumb is typically two pieces of credit (e.g. line of credit, credit card, car loan, student loan, etc.) with a minimum limit of $2,500 that’s reported to the bureau for at least two years. For folks that are looking to establish their credit history (usually younger or new to Canada), one tip we always provide is to ensure your rent is exclusive of utilities.
Try to pay your own utility bills or at least get your name on the bills as this will help build an alternative credit profile. Credit is simply a way for banks to track that someone sends you a bill and that you pay them back. With a credit card, you borrow money and pay it back. With a utility bill, you use the service and you pay for it. Because it’s a necessity and typically something you can’t cancel, it’s used as a barometer by banks for your ability to pay and pay on time.
Contact the Kyle Miller Mortgage Agent team to learn about how debt, mortgage applications, and the different financing options available to you!
Recent Comments