For homebuyers juggling debt, taking out a mortgage can feel like trying to convince a bouncer that you're “perfectly fine” after your fourth shot of tequila.
Lenders, often the spoilsports of home-buying ambitions, typically require that your debt-to-income ratio stay below a magical threshold. Monthly obligations such as credit card balances, car payments and other loans can cause this number to exceed the lender's limits.
However, just in case your bank gives you a polite “no thank you,” here are some legal ways to improve your approval chances without Las Vegas or lottery tickets.
What Lenders Want
Generally, top-tier lenders want a gross debt service ratio (GDS) of 39 percent or less and a total debt service ratio (TDS) of 44 percent or less.
This is how they are defined:
GDS:
Gross Income / (Mortgage payment + property tax + heating costs + half of all condo fees)
TDS:
Gross Income / (Mortgage payment + property tax + heating costs + half of all condo fees + other obligations)
Monthly figures are used to calculate these debt ratios. (And note: “Other obligations” doesn't include most utilities or things you can easily cancel, like cell phone bills.)
The problem is that every extra payment you carry tells the bank, “Please give me less money.” And they listen.
Take out car loans: TransUnion, the credit reporting agency, puts the average new car loan in Canada at $38,874, which sounds good until you realize it's essentially a small mortgage on four wheels. A six-year car loan at 6.9 percent means a monthly payment of $661. For a hopeful home buyer making $100,000 with a five percent down payment, this auto loan reduces the maximum mortgage amount by about 8.5 percent, or $37,000.
Some Debt Ratio Survival Tactics
If you're having trouble qualifying, here are a dozen tricks to help you keep your debt ratios to a minimum.
- Lose car payment: I often see borrowers taking out a car loan right before applying for a mortgage. It's like ordering dessert before stepping on the scale. Instead, use a ride-sharing app for a few months, book a long-term rental on a travel site, or use a peer-to-peer car app like Turo (Turo is like an Airbnb for cars). None of this will show up on your credit report, keeping your debt ratios low.
- Get temporary parental help: Mortgage lenders estimate the monthly credit card payment to be three percent of the outstanding balance, or $300 on a $10,000 plan. For first-time buyers in particular, using the Bank of Mom and Dad to pay off a loan before applying for a mortgage can mean the difference between owning a dream home or simply admiring the house from the sidewalk.
- Consolidate Debts with a Peer-to-Peer Lender: Companies like goPeer.ca and Fig.ca can convert large high-interest loan payments into smaller loan installments, reducing debt ratios. For example, with a credit card balance of $25,000, this can reduce monthly payments by a few hundred dollars, says goPeer founder Marc-Antoine Caya. “Paying off revolving debt with installment payments also reduces credit utilization, which can significantly improve credit scores,” he adds.
- Avoid condos with high fees: Many buildings, especially older ones, have condo fees that look like a second mortgage payment. This is a debt ratio killer. Additionally, there's nothing that reveals financial regret like paying $700 a month for a sauna you never use.
- Use a family gift to shorten your mortgage: The modern down payment strategy has become equal parts savings and parenting diplomacy. In fact, around four in ten buyers now rely on family support to purchase their first home.
- Move away from shared debt: If you co-sign on someone else's loan, the lender will charge you for it, even if the other person makes the payments. If enough time has passed since the loan was issued, ask the creditor to remove your name or have the primary borrower refinance in their own name before applying.
- Pay off debts that are almost due: Many people have debt that will be paid off shortly after their mortgage expires. Sometimes this involves high payments that show up on credit reports. Find a way to reduce your TDS ratio by paying it off early.
- Converting personal debt to business debt (for self-employed people): Move legitimate business debts onto company books. If the company makes the payments, lenders often exclude them from TDS entirely. Get professional accounting/tax advice on this.
- Get a co-signer: A solid cosigner can add more income to a mortgage application, reducing those burdensome debt ratios.
- Buy a Home with a Mortgage Helper: The income from a $1,500 per month second home could improve credit strength by over $90,000.
- Choose a lender with broader income recognition: Not all lenders view your income the same. Some allow business owners to collect income from bank statements, others allow income from appearances, still others allow landlords to use more of their rental income, and still others are more liberal when it comes to tips, commissions or overtime pay.
- Don't break up: Alimony and child support payments can sabotage a mortgage approval faster than your ex changes the WiFi password.
If your debt ratios refuse to cooperate, mortgage brokers still have a few tricks up their sleeves, including recommending lenders who:
- Grant more generous debt ratio allowances – albeit at higher rates and fees.
- Offer “equity programs” or allow “asset downsizing” as a form of income (for mortgage qualification purposes only). These programs can make your debt ratios look less dire. And while they aren't a solution for most people with debt ratio issues, they are a solution for some.
- Allow rent from subtenants or roommates. (Note: Such “income” is not accepted by most “prime” lenders.)
- Have lower “qualifying rates.” When assessing your ability to pay, top lenders will assume that your payment will be based on the contract interest rate plus two percent or 5.25 percent, whichever is greater. Often the term you choose determines your approval. For example, default-protected borrowers can now qualify for larger mortgages by choosing a six-month mortgage at 2.49 to 2.99 percent and later extending that into a longer-term mortgage. Lenders like Think Financial (owned by True North Mortgage) and Marathon Mortgage (available through brokers only) both play in this niche space.
The key to debt ratio gymnastics is that qualifying for a mortgage and comfortably paying it are two different things. Massaging your odds just to get past underwriting is like reveling in the extra legroom on a flight you had no business taking. It might feel like a victory until turbulence hits.
Robert McLister is a mortgage strategist, interest rate analyst and editor of MortgageLogic.news. You can follow him on X at @RobMcLister.
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