Buying a home? How credit card debt can affect your purchasing power

For most people, buying a home represents the single largest financial transaction of their lifetime. You might know that you need some savings for a down payment, or that you need good credit to be approved for a mortgage.

But do you know how credit card debt can affect your home purchasing power?

Credit card debt affects your debt ratios
Besides your income and down payment, another factor lenders use when qualifying you for a mortgage is your debt ratios.does-cc-debt-affect-morgage

"Lenders use debt ratios to determine how much money they'll let you borrow for a mortgage," Sean Schumacher, a mortgage agent at Safebridge Financial Group, said in an emailed response to questions.

There are two main debt ratios: Gross Debt Service Ratio (GDSR) and Total Debt Service Ratio (TDSR).

Gross Debt Service Ratio: The GDSR looks at how much of your gross monthly income is required to cover housing-related expenses, including your mortgage, property taxes, heating and 50 per cent of maintenance fees. To determine your GDSR, add your housing-related expenses and divide by your gross monthly income. Here's the basic formula:

GDSR = (Mortgage + Property Taxes + Heating + ½ Maintenance Fees) / Gross Monthly Income

So, if you had a monthly mortgage payment of $1,250, property taxes of $210, heating of $75 and gross monthly income of $5,400, your GDSR would be:

GDSR = ($1,250 + $210 + $75) / $5,400 = 28.43%

Total Debt Service Ratio: The TDSR is a lot like the GDSR. It includes all your housing-related expenses, but on top of that, it also includes any other debts you may have. This is where credit card debt comes into play. To determine your TDSR, add your housing-related expenses and other debt, and divide by your gross monthly income. Here's the basic formula:

TDS = (Mortgage + Property Taxes + Heating + ½ Maintenance Fees + Other Debt) / Gross Monthly Income

If you had a monthly mortgage payment of $1,250, property taxes of $210, heating of $75 and gross monthly income of $5,400 and monthly credit card payment of $200, your TDSR would be:

GDSR = ($1,250 + $210 + $75 + $200) / $5,400 = 32.13%

Qualifying for a mortgage
When applying for a mortgage, lenders are required to use the debt ratios to "stress test" you to ensure you can handle your mortgage payments, other housing-related costs and debts.

When it comes to your credit score, there are two tiers of mortgage qualification: those with credit scores below 680 and those with credit scores above 680. If your credit score is below 680, the maximum debt ratios allowed by lenders is 35 per cent for the GDSR and 42 per cent for the TDSR. However, if your credit score is over 680, you'll get a maximum GDSR of 39 per cent and TDSR of 44 per cent.

"By having a better credit score, you're rewarded with an extra 4 per cent of qualifying room," said Schumacher. "If your credit score is above the maximum debt ratios allowed by lenders, traditional lenders may turn you down, and you may have to turn to shadow lending and pay higher mortgage rates."

Tips for improving your credit score
Before you go house hunting, it's a good idea to get pre-approved for a mortgage with a lender. A mortgage pre-approval tells you the maximum amount you're approved to spend on a home.

"Without a mortgage pre-approval, the results can be disastrous," Schumacher said. "You buy a home, only to be turned down by the lender because you've spent more than the lender is willing to approve."

Before applying for a mortgage pre-approval, though, you should check your credit score. If your credit score is below 680, the designated "good" range, don't panic. There are things you can to do improve it.

If you have any unsecured debt, such as credit card debt, focus on paying off that first. In the TDSR, 3 per cent of the outstanding balance on your credit card is used. For example, if you owe $8,000 on your credit card, that counts as $240 toward your TDSR.

"By paying down your unsecured debt, you can improve your credit score and lower your TDSR ratio at the same time," said Schumacher. "This lets you borrow more money from the bank toward the purchase of a home."

Canada recently introduced a new "stress test" lenders are required to apply on mortgages with less than a 20 per cent down payment.

"Under the new mortgage rules in Canada, homebuyers lost an average of 20 per cent of their purchasing power," said Schumacher. "You can gain some of that back with a higher credit score. That starts with your credit card and using it responsibly by paying off your balance in full each month."

Lenders also are looking for different types of credit. If you just have one type (e.g., a credit card), it can negatively affect your credit score. That being said, you want to use other forms of credit, such as a line of credit, responsibly.

"If you're using more than 35 per cent of your available credit, it can lower your credit score," said Schumacher.

If you're planning to apply for a mortgage, try not to apply for any other credit, such as credit cards, beforehand. Too many credit inquiries in a short period of time can hurt your credit score, and thereby hurt your chances of getting a mortgage.

See related: 5 common credit score mistakes, Getting specific with 3 common, broad financial goals
Published December 30, 2016

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