How does different debt affect your approval?

Dream of owning a home, or a different home? Your debt is a big part of the (mortgage) picture that you need to consider. Here's how lenders see your debt when you want to buy a home or property in Canada.

Lenders like it when you manage debt well. But not all debt is created equal.

Do you have debt? You're not alone. Excluding mortgages, the average consumer debt in Canada just clocked in at $20,739 (according to an Equifax press release November 30, 2021), with the average Canadian adult owning at least 2 credit cards.

The thing is, having a good credit history can actually help you secure a mortgage loan. And managing your debt well can help you qualify for a higher amount or a lower interest rate.

But are certain types of debt harder on your mortgage pre-approval than others? While lenders like to see a diverse credit history, not all your debt is viewed the same way. As well, some debt-types have the potential to carry increasingly-higher balances, which can make it more important (or harder) for you to keep your debt in check.

Here's how different kinds of debt can affect your pre-approval.

Lenders will treat a debt-type in one of two ways: they'll either take the entire balance (which they calculate into 'monthly' payments at their own percentages), or they'll take the actual monthly-payment-hit on your cash flow. Plus, for your own bottom-line, some types are easier to budget and pay down than others — helping to keep your debt service ratios down and credit score up.

Federal Debt

Canada Revenue Agency (CRA). Entire balance, paid off asap. This type of debt is an instant no-go. If you owe back taxes or are in arrears, you'll be asked to clear this debt before a lender will consider your pre-approval.

Credit Card, Line of Credit Debt

Revolving, Unsecured. Entire balance. For this type of debt, a lender typically looks at the entire balance to calculate an amount you should be paying every month to clear it off, regardless of how much you actually pay down per month. The higher the balance, the quicker it adds up in lender calculations, and the more it works against your mortgage-borrowing potential.

  • Lenders want to see regular payments on this type of debt, especially if you carry balances from month-to-month (try not to spend more than 75% of your limit, or clear your balance often if you do).
  • The 'minimum' amount is just that, and will work against your credit score if you continue to pay only this amount.
  • Even with consistent payments, higher balances will still factor into your credit utilization rate and debt service ratios — though a lender may consider the consistency in your overall credit picture.
  • With a Line of Credit (LOC), some lenders may base their calculations on the entire limit, regardless of balance.

Mortgage Debt

Secured. Monthly-payment amount. A mortgage is a type of instalment debt, but usually much larger and therefore paid back over several more years (25 years is standard). Lenders will use your potential monthly payment based on your affordability numbers (or your actual payment if you already have a mortgage) when calculating your debt service ratios.

  • A mortgage is likely the largest financial commitment you'll have, so it likely takes a larger portion of your monthly income. But because it's already spread out over many years, it may factor less than carrying high balances in other debt types (such as credit cards).
  • Carrying more than one mortgage is possible if you have the income or equity to qualify (for example, if you have an investment property or second home mortgage).

Instalment Debt

Secured. Monthly-payment amount. A vehicle loan is an example of this debt-type. The fixed payments (typically set for a period of 1 - 8 years) can be easier to budget around than revolving credit (where monthly repayment can climb in a short period of time). Lenders calculate these payment amounts into your monthly debt-service ratios, rather than factoring in the entire loan balance.

  • Instalment loans usually take less time to pay off compared to mortgage debt, but they're still a long term commitment (think monthly cash flow!).
  • When adding this type of debt, allow room enough for other expenses or debt that may come along.
  • Because instalment debt payments are usually the same every month, they can be easier to manage (compared to revolving credit).

HELOC Debt

Revolving, Secured. Entire balance. Different than a Line of Credit (LOC), which is unsecured and usually carries a higher interest rate — many people use a Home Equity Line of Credit (HELOC) to consolidate higher-interest debt, or for larger expenses, such as home renovations. This type of debt is calculated out like a mortgage, rather than a percentage of the balance.

  • A HELOC is secured by your home or property, so is more flexible and less weighted for your pre-approval than an unsecured LOC.
  • But, this type is still 'revolving,' which means the balance can be increased at your discretion, with a direct affect on your debt service ratios.

Student Loans

Entire balance. If you have pending or active student payments, lenders calculate a portion of the entire balance into your monthly debt load. For the most part, student loans carry lower interest and more flexible payback schedules, and are less-weighted compared to, say, credit card debt.

Spousal or Child Support Payments

Monthly-payment amount. Lenders factor these payments into your debt service ratio if you're paying out. If you're receiving these payments, a portion is added to your monthly income.

Debt is just that. How well you pay it back can actually help your pre-approval.

Ultimately, how you manage your debt is reflected in your credit score, and directly affects your overall monthly debt service (debt-to-income) ratios, both of which are used by lenders to qualify you.

No matter what debt you have, being realistic with your income and budget will help you keep up consistent payments for a healthier credit picture. And the longer you can show a good history of paying your debt, the easier it will be to get your preferred lender, or an even better rate, on board.

How lenders treat your debt can be complicated. But we make it easy to understand.

Looking to buy a home? Our amazing True North Mortgage brokers can help you with all your debt questions — in your preferred language — and can quickly process your pre-approval so that you know exactly where you stand, and which lender is your best fit.

Curious about your credit report? You can check it out for free with Equifax Canada

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