How Car Loans, Student Debt, and Credit Card Balances Impact Mortgage Affordability
Extremely few Canadians pay for their house in cash — almost all of us will be forced to borrow in order to buy a property. In 2016, mortgages accounted for 80.7% of the total debt carried by Canadian families, up from 77.4% in 1999, according to Statistics Canada.
That’s not necessarily a bad thing, especially when interest rates are at near historic lows. Taking on a mortgage allows borrowers to upgrade our lifestyle, build up equity over decades and potentially even use any extra savings to invest in something that has a higher rate of return than the debt costs.
If we all had to save up to pay for a property in full, very few of us would ever be homeowners. The benchmark price for Vancouver houses for sale, for example, reached $993,300 this August, while average sold prices for townhouses for sale in Toronto are now $597,400.
Mortgage Stress Test Has Made it Tougher to Qualify
But it’s been increasingly difficult to even qualify from a mortgage since the federal bank regulator put in new rules on January 1, 2018. Now, borrowers must be able to support a mortgage that is at least 2% above their contract rate. Both the Canadian Real Estate Association and the Toronto Real Estate Board have blamed these tighter lending rules for stagnant prices in expensive detached homes and the move towards higher-density, less expensive forms of housing like condo units. Borrowers, especially first-time mortgage borrowers, are having increasing difficulty getting any financing at all.
That’s because even if a borrower has a high income if most of their income is already called for — such as car payments or student loans— then they have less to spend on the mortgage and are more likely to default should something unexpected happen, like a job loss.
How Is Mortgage Qualification Calculated?
Banks determine a borrower’s affordability by taking into account the household’s after-tax income, subtract their debt obligations and then see if there’s enough income left over to support a mortgage even if rates go up 2%, plus property maintenance costs like utilities and property tax.
There are two official formulas lenders use to calculate the risk of lending to you — the Gross Debt Service ratio and the Total Debt Service ratio. First, to qualify for the Gross Debt Service ratio, borrower’s monthly housing costs must be less than 32% of their income. Second, to qualify for your Total Debt Service Ratio, all debts plus housing costs must be less than 40% of your household income.
What Can Borrowers Do to Improve Their Chances of Qualification?
It’s not all black and white though — depending on credit history borrowers may be able to exceed these ratios.
If borrowers are simply not qualifying for as big a loan as they need, there are three things they can do:
- Seek out an alternative lender, like a credit union, a private lender or a smaller bank.
- Pay off any car, student and credit card debt and apply again
- Save up a bigger down payment to reduce the mortgage needed
Ultimately, the bank determines how much mortgage you can afford based on sound financial principles — the last thing anyone wants is to feel strapped or house poor. On a bigger level, Canadian debt levels are so high — 20% higher than in 2007— the entire economy is vulnerable to any shock, like a recession, a dip in home prices or an interest rate rise. It may feel unfair, or frustrating to have your car and student and credit card loans holding you back from buying a home, but it’s worse to feel the overwhelming pressure of paying off multiple forms of debt.
The best thing to do to increase the amount of mortgage you can afford is to reduce the amount of debt you carry.
Zoocasa is a full-service brokerage that offers advanced online search tools to empower Canadians with the data and expertise they need to make more successful real estate decisions. View real estate listings at zoocasa.com or download our free iOS app.