Student Loans, Lines of Credit and Credit Card Debts: How They Affect Your Mortgage Qualification

September 8, 2017 | Posted by: Don Chen

It is inevitable to have debt these days. Most of us use some form of borrowed money, ranging from car loans, student loans, credit card loans, lines of credit and the biggest loan of all, a mortgage. Some loans are more dreaded than the others, and depending on the purpose of the loan, your financial plan and goals, and your tolerance of risk, a loan can work in your favour to improve your long term financial health. As a mortgage agent, I arrange the right mortgage product to meet my clients’ needs. A mortgage scares many but when it’s managed properly, it will help boost your asset portfolio for many years to come. In this blog, I want to discuss how some of the more common types of loans can impact your mortgage qualification, and how you can set yourself up in a better position to acquire the mortgage you need for your dream home, cottage or investment property.

I’m gonna be using the word liability a lot in my writing as that is what we call any sum of money you borrowed and are currently (or not) paying back on.  The one thing that all types of loans have in common is that, the bigger your debt is the less mortgage you can qualify.  Take a look at my previous blog to see the simple formulae we use to calculate your qualified mortgage amount: Mortgage Qualification for First Time Home Buyer.

The first debt to address is the student loan.  For many first time home buyers, this is the first thing they should work on reducing before they apply for a mortgage.  More than once, I find out that the client has an outstanding student loan that I was not informed about initially, because the client didn’t feel the need to mention it since he/she has not started paying. The problem is, it’s still a LOAN. In this case, when the report shows zero payment on the loan, we will use 1-3% of the outstanding balance into the mortgage calculation as liability. To put this in perspective of purchasing power, if a person has a $30,000 student loan and there’s no regular repayment being made, he/she is facing $300 to $900 of liability added to the mortgage calculation and that equates to reduction by 13% and 40% respectively in purchasing power (on an 60k/annual income). Now how to put yourself in a better position? The trick (no trick at all) is to get on a repayment plan and start paying the loan back as soon as possible. Using the same example, if the applicant has an existing repayment of $150/M, that $150 will be used in the calculation instead of the 1-3% of the balance.

Next up is the line of credit (LOC). When it comes to LOC there are two types, unsecured line of credit and secured line of credit.  The difference between the two is that, a secured LOC is a loan that is secured against an object that the lender can take possession of and sell to recuperate the loaned money in case of a client default. The most common example of a secure LOC is a Home Equity LOC (HELOC) which is secure against a real estate property. Secured LOC allows a big loan amount (100k-800k), whereas unsecured LOC allows a much smaller amount (10-50k) as it carries more risk to the lender.  Knowing the type of LOC you have is important, because it ties back to how much liability is used in the mortgage application. To calculate the liability amount of secured LOC, you can use the your LOC limit (not just the balance) multiplied by 0.65%, or pretend to amortize it into a 25 year at benchmark rate and the monthly payment will be the amount that goes into the liability.  Now as for unsecured LOC, you would take the outstanding balance and multiple by 3%, or you can use the amount you are currently paying back.  For example, an unsecured LOC of $15,000 would yield a liability of $450, and a secured LOC of $100,000 yield a liability of either only $650 or $575. As you can see, because a secured LOC is less risk, often it has less negative impact on the mortgage application. Just be aware that liability calculation for secured is based off of the total credit limit, and for unsecured it’s based off of the outstanding balance.

Now that we have address the two more complicated and confusing types of loans. Let’s look at the last item on the list, credit cards. Generally we see credit limits of $5,000 to $20,000 on credit cards.  Lenders typically want to see reasonable payments on the report ranging from1%-3% of the outstanding balance. In cases where no payment is reported, a 3% of balance is used in liability. The guidelines surrounding credit card debt is fairly straightforward compared to the previous loans we covered.

A few hundred here and a few hundred there may not seem like a lot, but the matter of the fact is that debt adds up. The more debt that a person accumulates the less motivated the person is to pay it back, and it will come back with a vicious bite when you try to get a mortgage. To give you an idea of how debt can drop your qualified mortgage amount, on an average salary of $60,0000/year with every one hundred dollars of debt inputted as liability on the mortgage application, the amount of mortgage one can qualify for drops by approximately 4%.  If your goal is to maximize the amount of mortgage you can borrow, then start by reducing your debt or start a repayment plan that fits your financial strategy. If you have any questions about how to structure your liabilities and maximizing your mortgage qualification, feel free to contact me any time.

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