For most people, buying a home is the biggest financial commitment they’ll ever make. While you might know that you need some savings for a down payment and good credit to be approved for a mortgage, you might not realize how credit card debt can impact your ability to buy a home.
How Credit Card Debt Affects Your Debt Ratios
When you apply for a mortgage, lenders consider your income, down payment, and your debt ratios. Sean Schumacher, a mortgage agent at Safebridge Financial Group, explains that debt ratios help lenders determine how much money they will lend you.
There are two main debt ratios: Gross Debt Service Ratio (GDSR) and Total Debt Service Ratio (TDSR).
- Gross Debt Service Ratio (GDSR): This ratio measures how much of your gross monthly income is needed to cover housing-related expenses like your mortgage, property taxes, heating, and half of your maintenance fees. The formula is:GDSR = (Mortgage + Property Taxes + Heating + (1/2 * Maintenance Fees)) / Gross Monthly IncomeFor instance, if your monthly mortgage payment is $1,250, property taxes are $210, heating is $75, and your gross monthly income is $5,400, your GDSR would be:GDSR = ($1,250 + $210 + $75) / $5,400 = 28.43%
- Total Debt Service Ratio (TDSR): This ratio is similar to the GDSR but includes all your debts, such as credit card debt. The formula is:TDSR = (Mortgage + Property Taxes + Heating + (1/2 * Maintenance Fees) + Other Debt) / Gross Monthly IncomeIf your monthly credit card payment is $200, then your TDSR would be:TDSR = ($1,250 + $210 + $75 + $200) / $5,400 = 32.13%
Qualifying for a Mortgage
Lenders use these ratios to “stress test” your ability to handle mortgage payments, housing costs, and other debts. Mortgage qualification varies based on your credit score. For scores below 680, lenders cap the GDSR at 35% and the TDSR at 42%. For scores above 680, the caps are 39% and 44%, respectively.
“A better credit score rewards you with an extra 4% of qualifying room,” says Schumacher. If your ratios exceed these limits, you might need to turn to shadow lenders, who charge higher rates.
Tips for Improving Your Credit Score
Before house hunting, get pre-approved for a mortgage. This tells you the maximum amount you can spend on a home. “Without pre-approval, you risk buying a home only to be turned down by the lender,” warns Schumacher.
First, check your credit score. If it’s below 680, don’t panic—there are ways to improve it. Focus on paying off unsecured debts like credit card balances, which count toward your TDSR. For example, $8,000 in credit card debt counts as $240 toward your TDSR.
“Paying down unsecured debt can improve your credit score and lower your TDSR, allowing you to borrow more for a home,” Schumacher advises.
New mortgage rules in Canada, like the stress test for buyers with less than a 20% down payment, have reduced purchasing power by about 20%. “You can regain some of that with a higher credit score,” says Schumacher. This starts with using your credit card responsibly by paying off the balance each month.
Lenders also like to see a mix of credit types. Relying solely on a credit card can hurt your score. Using a variety of credit forms, like a line of credit, responsibly is beneficial.
“If you use more than 35% of your available credit, it can lower your score,” Schumacher notes.
Before applying for a mortgage, avoid applying for new credit. Multiple inquiries in a short period can hurt your credit score and your mortgage approval chances.
By understanding how credit card debt affects your debt ratios and taking steps to improve your credit score, you can enhance your chances of qualifying for a mortgage and buying your dream home.
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