Understanding the way debt – especially unsecured debt – comes into play when qualifying for a mortgage can be unclear for many borrowers.
You have zero credit card debt, but you pay $300 a month to finance your car. That makes you much more desirable than your neighbour who has managed to rack up $10,000 in credit card debt, right? NO! The truth is, from a lender’s debt servicing perspective, both of you are considered to be paying $300 a month towards your debt.
While $10,000 in credit card debt won’t typically result in a $300 monthly payment commitment (as there is a minimum payment requirement and a balance can be carried), the mortgage lender will apply a $300 payment for the $10,000 in unsecured debt as they typically use a calculation based on 3% of the outstanding balance.
So, if you have a $300 monthly car loan PLUS a $300 monthly obligation to pay off credit card debt, you can see how your mortgage qualification amounts can quickly begin to dwindle.
A monthly debt obligation of $600 reduces your purchasing power by approximately $100,000 based on today’s interest rates! That’s a lot of house you could be missing out on because you’re carrying debt.
If you have equity built up in your home, it makes sense to roll your unsecured debt in with your mortgage. Not only will you pay a much lower interest rate on your secured mortgage debt, but your monthly debt commitments will decrease significantly, empowering you to qualify more easily for future mortgages.
If you’re planning to buy a home in the future, every dollar not currently going towards saving for a down payment and your current monthly obligations should be used to pay down unsecured debt. This will increase your buying power when it comes time to qualify for a mortgage.
The key is to ensure once you’ve paid down your debt that you don’t find yourself in a similar position down the road. Every debt you undertake should include a plan to be paid off in full over a manageable amount of time to ensure it doesn’t get out of control. Budgeting will help ensure you can afford items for your home as well as regular maintenance and other expenses that come along with homeownership.
Do you have questions about qualifying for a mortgage or how to pay down debt? Answers are a call or email away.