It’s back-to-school season for many Canadians across the country. For those who have finished school, you may have some student debt weighing you down. Buying a home might be on your to-do list, but can you do so with student debt you haven’t paid off yet? On top of that, you might have car payments to make as well. How do these loans impact mortgages and your ability to buy a home?
Student and car debts are both unavoidable for many people, but they shouldn’t get in the way of securing a mortgage. If you’re responsible and consistent with these payments, odds are, you can still buy a home! Let’s explore what you need to know about these debts before you apply for a mortgage.
The key debt service ratios
It’s important to understand the key debt service ratios lenders look at when considering your mortgage application. These give lenders a glimpse into your financial situation, and help them decide if they will approve you as a borrower. First, we have the Gross Debt Service (GDS) ratio. This calculates how much of your household income is used to make your mortgage payments, and pay your property taxes and heat. This amount shouldn’t exceed 39 per cent of your total income. Second, we have the Total Debt Service (TDS) ratio. This calculates how much of your household income is used to pay for your mortgage, property taxes, heat, and your debt. This amount can’t exceed 44 per cent of your total income. Keep these in mind as we discuss the types of debt below!
Good versus bad debt
First, let’s start with the difference between “good debt” and “bad debt” and whether the type of your loans impact your ability to secure a mortgage. Student loans are considered good debt while car loans are often considered bad debt, but what does that mean? Good debt is debt that will advance your opportunities for earning money, or improve your financial situation in some way. A student loan is good debt because it ideally leads to career opportunities and income. Mortgages are also good debts because most homes appreciate in value, and you can build home equity.
Car loans are technically “bad” because almost no cars appreciate in value over time, and you will never earn back what you paid for it. However, cars serve essential purposes and are unavoidable for many people. Don’t avoid getting a car just because they fall into the bad debt category. If they serve you a purpose, they are not a waste of money for you. Plus, the type of loan you have doesn’t matter to lenders when they are considering you for a mortgage. If you pay $500 per month, it makes no difference to your debt service ratios whether this is for a car loan or student loan. In short, good debts and bad debts are all the same when it comes to getting a mortgage.
How big are your loans?
How do the sizes of car and student loans impact mortgages? One of the first things you should think about is how big your current debts are. Consider how much you pay every month for these loans, and how much of your income and credit those payments take up. When you apply for a mortgage, lenders examine your debt-to-income ratios to see how prominent debts are in your life. If they find your debts are taking up too much of your income, they are less likely to approve you for a mortgage. As we mentioned, your debts, including your mortgage, shouldn’t cost more than 44 per cent of your gross income. Otherwise, you might get approved for a smaller mortgage, which means a smaller budget for you.
Car and student loans themselves don’t necessarily have a bad impact on your mortgage application. It’s all about how you handle the payments. Most of us have some monthly payments to make – rent, utilities, credit cards, etc. Car and student loans are likely to be two of your biggest monthly payments, so it’s extra important to make these on time. If you miss these payments often, this shows lenders you struggle with larger debts, and they are less likely to approve you for a mortgage. Missing these important payments can also lower your credit score. Lenders can be flexible with the credit scores they will accept, but you should strive for a score of at least 670. This will put you in the “good” category. Having a good credit score can help you secure a mortgage to buy a home, because it shows lenders you are responsible with money and making payments.
Can these loans help at all?
As it happens, car and student loans can impact mortgages for the better. While missing payments can lower your credit score, you can use these loans to your advantage to raise your score. These loans provide a chance to show lenders you are responsible for making large payments. If you consistently make payments on time, your credit score can increase, which boosts your chances of holding favour with lenders.
If you have car and student loans, is it best to fully pay them off before applying for a mortgage? If you know buying a home is a goal for you, make it a priority to pay off your current loans on time so they don’t have a negative impact on your mortgage application. You don’t need to fully pay them off, but you must show you can handle additional payments. A small amount of debt will not have an impact on how much of a mortgage you will be approved for, since your TDS ratio can be greater than your GDS ratio. However, the more debt you have, the less you will qualify for. That doesn’t mean car payments or student loans will stop you from getting a mortgage! You will just qualify for less than you would if you didn’t have these payments.
There’s no doubt that car and student loans impact mortgages, but you can influence whether they affect your application in a positive or negative way. It’s super important to understand how much debt you have, whether you can handle an additional loan, and how lenders are likely to view your situation. You should also get in touch with a broker! Mortgage brokers are your top resource for getting a grip on your financial circumstances before applying for a mortgage.
If you have any questions about getting a mortgage, get in touch with me!