How does different debt affect your approval?
Navigating Debt in Your Mortgage Pre-Approval: A Comprehensive Guide
Securing a mortgage pre-approval involves more than just assessing your income and property value; lenders scrutinize various types of debt to evaluate your financial health. Understanding how different debts impact your pre-approval process is crucial for making informed decisions. In this guide, we break down the intricacies of various debt types and how lenders treat them in the context of mortgage pre-approval.
7 different types of debts in Canada
- Federal Debt: Canada Revenue Agency (CRA):
- Entire balance, to be paid off promptly. Considered an immediate obstacle. Lenders require resolution of any back taxes or arrears before proceeding with a pre-approval. Pay these back asap or you won’t be issued a mortgage.
- Credit Card, Line of Credit Debt:
- Revolving and unsecured, this category of debt entails considering the entire balance when assessed by a lender. The lender calculates a monthly payment amount necessary to clear the debt, irrespective of the actual monthly paydown.
- Higher balances escalate quickly in lender calculations, potentially hindering your mortgage-borrowing potential. Regular payments are crucial, especially for revolving credit. Consistently paying only the minimum amount can adversely affect your credit score.
- Mortgage Debt:
- Secured with a monthly payment amount, a mortgage falls under the category of instalment debt. However, it typically involves a much larger sum, necessitating repayment over an extended period, with 25 years being the standard duration. Lenders determine your potential monthly payment based on your affordability metrics or your actual payment if you are already servicing a mortgage.
- Given that a mortgage is likely your most substantial financial commitment, it tends to consume a significant portion of your monthly income. However, due to its extended repayment timeline, it may carry less weight in comparison to maintaining high balances in other debt types, such as credit cards.
- It’s worth noting that carrying more than one mortgage is feasible if you possess the income or equity to qualify. This scenario could arise, for instance, if you have an investment property or a second home mortgage.
- Instalment Debt (e.g., Vehicle Loan):
- Secured, with a monthly payment amount, an example of this type of debt is a vehicle loan. Characterized by fixed payments typically spanning 1 to 8 years, this debt type offers easier budgeting compared to revolving credit, where monthly repayments can swiftly increase. Lenders calculate debt-service ratios based on your fixed payment amounts rather than considering the entire loan balance.
- While instalment loans often have a shorter payoff period than mortgage debt, they still represent a long-term commitment, demanding careful consideration of monthly cash flow. When incorporating this debt type, it’s essential to leave room for potential additional expenses or other debts that may arise. The consistent, predictable nature of instalment debt payments each month makes them more manageable than the variability often associated with revolving credit.
- HELOC Debt (Home Equity Line of Credit):
- Revolving and secured, this type of debt encompasses the entire balance. It differs from a Line of Credit (LOC), which is unsecured and often carries a higher interest rate. Many individuals opt for a Home Equity Line of Credit (HELOC) to consolidate higher-interest debt or cover significant expenses like home renovations. Unlike a percentage-based calculation, this debt is assessed similarly to a mortgage.
- A HELOC, secured by your home or property, offers more flexibility and carries less weight in your pre-approval compared to an unsecured LOC. However, it retains a ‘revolving’ nature, allowing you to increase the balance at your discretion, directly impacting your debt service ratios.
- Student Loans:
- Entire balance. Portion of the entire balance factored into your monthly debt load. Typically less ‘weighted’ compared to high-interest debt, such as credit cards.
- Spousal or Child Support Payments:
- Monthly-payment amount. Factored into your debt service ratio if you’re paying, while a portion is added to your monthly income if you’re receiving payments.
Debt is precisely that – a financial obligation. The manner in which you fulfill these obligations can significantly impact your pre-approval. Ultimately, your debt management reflects in your credit score, directly influencing your overall monthly debt service ratios—criteria that lenders use to assess your eligibility.
Regardless of the type of debt you carry, maintaining a realistic approach to your income and budget is crucial for sustaining consistent payments and cultivating a healthier credit profile. Demonstrating a commendable history of debt repayment over time enhances your chances of securing your preferred lender or even obtaining a more favorable interest rate.
Understanding how lenders navigate your debt can be complex, but we simplify the process for you. If you’re in the market to buy a home, We are here to assist with all your debt-related inquiries. We can efficiently process your pre-approval, providing clarity on where you stand and identifying the lender that best aligns with your needs.
For those curious about their credit report, Equifax Canada offers a free and accessible way to review your financial standing.
