Debt is universal. Most people experience some sort of debt in their lifetime. A significant number of Canadians experience outstanding debt, whether it’s in the form of student loans, mortgage loans, car leases, home loans, or lines of credit.
Credit card debt is the most common outstanding debt amongst Canadians, with 29% of Canadians holding credit card debt. Credit card debt can affect mortgage loan eligibility. In both positive and negative ways. Lenders assess your monthly income, credit score and credit history, and your amount of debt. This also includes credit card debt when deciding to approve your mortgage application. These factors also influence the mortgage interest rate you’re approved for.
But, credit card debt isn’t always a bad thing when it comes to buying a home. Let’s explore some ways your credit card debt can influence your ability to get a mortgage.
Understanding How Mortgage Lenders Look at Credit Card Debt
Lenders don’t apply the same lens to all mortgage applications that display credit card debt. They know that people have different relationships with credit card debt, some relationships being healthy and others not so much. Lenders consider debt-to-income ratio, credit utilization ratio, and reasons for credit card debt when assessing your mortgage application.
Your debt-to-income ratio (DTI) weights your total debt payments against your total income. To calculate your DTI:
- combine the value of all monthly debt, including interest and insurance;
- divide the total by your total monthly income, and
- multiply by 100.
Lenders use your DTI as a metric in deciding your reliability for a loan. Generally, DTIs of 41% or higher is too high. With a DTI in that range, you risk mortgage rejection. Otherwise, approve or being approved with an exorbitant interest rate and rigid terms. Having a high DTI is a red flag for lenders, as it shows that a high portion of your income is already going towards debt.
So, high credit card debt doesn’t necessarily equate to a mortgage loan rejection. Even if your debt is high, you could have a significant enough income that brings your DTI to a favourable value.
Credit Limit and Credit Utilization Ratio
Having a high credit limit doesn’t mean you should use all of it. It’s generally a good practice to keep your credit card balance well below your credit limit. This is known as your credit utilization ratio. Reaching your credit limit negatively affects your credit score, and also shows lenders that you’re financially strained.
Lenders look at your credit limit when assessing credit card debt. For example, if you have $6,000 in credit card debt and your limit is $6,500, you might be seen as riskier than someone with $6,000 in credit card debt, with a limit of $10,000.
This is a great example of how the amount of credit card debt isn’t examined on its own – lenders also assess its relation to your credit card limit.
Reason for Credit Card Debt
Some lenders examine the reason behind your credit card debt when assessing your mortgage application. A borrower who frivolous items with credit might be seen as less reliable than a borrower that used up their credit essentials such as medical bills.
If you’ve spent most of your credit card balance on vacations, fancy restaurants and clothing, a lender might doubt your ability to make sound financial decisions. Before applying for a mortgage, try to limit the spending of this nature.
How Can My Credit Card Debt Negatively Influence My Mortgage
If you have significant credit card debt with a high debt-to-income ratio, high credit utilization ratio, and frivolous reasons for debt, you risk a mortgage loan rejection. If your mortgage application is accepted with unfavourable credit card debt circumstances, you risk being subject to high mortgage interest rates, which can pull you further into debt if you’re not careful.
Some lenders may also be more rigid in their mortgage terms. For example, they may refuse a high amortization period, and insist you pay back the loan in a shorter period of time. Others might look for an opportunity for collateral, or request that you apply with a co-signer or guarantor.
How Can My Credit Card Debt Positively Influence My Mortgage Application?
If you have significant credit card debt but have an ostensibly healthy relationship with debt, lenders might actually see the debt as a reason to approve your mortgage loan. By healthy relationship, we mean a decent debt-to-income ratio, low credit utilization ratio, and minimal frivolous spending with credit.
Lenders might look favourably on healthy debt because it demonstrates both diversification of debts, and an ability to responsibly manage your personal finances.
What Should I Do Before Applying for a Mortgage?
If you have the flexibility of extra time before applying for a mortgage, try to follow these simple steps to decrease the risk of credit card debt hurting your application:
- Surpass your minimum credit card payments on time for a few months
- Check your credit report
- Improve your credit score
- Limit your credit utilization ratio
- Lower your debt-to-income ratio
- Refrain from applying to new credit cards shortly before you apply for a mortgage
- Use credit building products or enlist the support of a credit counsellor to minimize your debt
Dealing with credit card debt is a daunting task on its own. It’s even more daunting when you know debt can affect mortgage applications. You can help mortgage lenders perceive your credit card debt as low risk. Just make your minimum payments on time, limit your spending, and keep your credit utilization ratio low.