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What to consider when buying a home with debt

Should you embark on the journey of homeownership if you already have debt? Many people are unsure whether they can buy a home with debt, or if it is a good idea to do so. The short answer is yes, you can purchase a home with existing debts. However, there is much more to it than that! Here are the key items to consider before deciding to enter the housing market.

It is possible to buy a home with debt!

Purchasing a home with debt is becoming increasingly common. Most Canadians have some form of debt, whether through other loans, credit cards, lines of credit, etc. Things like student loans and car payments can take a long time to pay off as well. It is fairly normal to apply for a mortgage when you have other debts on the go. In fact, it can be tricky for people to be completely debt-free before buying a home. This means you don’t need to automatically count yourself out of homeownership if you have debt. Of course, there are limitations here, which we will discuss below. While you might technically be able to buy a home with debt, that doesn’t mean you should.

Understand your debt service ratios

Your debt service ratios are some of the most important items to consider when you are thinking about buying a home with debt. Lenders will examine these ratios closely when they are evaluating your mortgage application. 

The first ratio to understand is your Gross Debt Service (GDS) ratio. This calculates how much of your monthly income is required to pay for housing expenses. This includes items such as mortgage payments or rent, property taxes, utilities, etc. It strictly focuses on housing costs, so it does not take into account any other expenses. We can calculate this ratio by dividing your expected costs by your monthly income. According to the Canada Mortgage and Housing Corporation (CMHC), an ideal ratio is 35 per cent or below. This means you should not need more than 35 per cent of your monthly income to cover housing expenses.

The second ratio is your Total Debt Service (TDS) ratio. This determines how much of your monthly income is needed to cover all of your expenses. This takes into account life expenses that don’t involve housing, such as credit cards, loans, internet, and any other expected costs. This ratio should be below 42 per cent.

With both of these ratios, the lower the score, the better. This implies you do not need to use a majority of your income to cover your expenses, which provides assurance for lenders. However, many lenders will work with a more flexible range of ratios than the recommended maximum. This will likely result in higher mortgage rates, so keeping your score as low as possible is your best move.

Consider your mortgage approval

While you might be approved for a mortgage with debt, your approval amount might be smaller than you would like. If your lender has any reservations about your ability to make mortgage payments, they might limit the amount they are willing to finance. This protects them in the event of a mortgage default. Depending on your purchasing plans, this might pose an issue. It can restrict your budget, which can limit your options. Your lender may also charge higher interest rates due to your existing debts, which is another factor to consider when evaluating your ability to support a mortgage.

Watch out for the risk of becoming house poor!

Being house poor is an undesirable outcome of homeownership that is not that uncommon. It means you need to use a majority of your income to support your household expenses. This leaves you with little room to support your other financial obligations, from other debts to things like groceries or child care. As you can imagine, this can cause a lot of stress for home owners. Being house poor means running the risk of being unable to make your payments, which could ultimately lead to defaulting on your mortgage. You need to know what you can and cannot afford before buying a home with debt so you can avoid this risk. You should never purchase a home you can’t truly afford.

Always consult a broker

For the best experience buying a home with debt, make sure you work with a mortgage broker! From your debt service ratios, to securing a lender, to dodging the possibility of becoming house poor, brokers are there for you every step of the way. Your mortgage needs are unique, and you might need some extra guidance when you already have existing debt. This will impact the products you qualify for, and the lenders you can work with. As industry experts with connections, we can ensure you secure the perfect fit for your purchasing journey.

Buying a home with debt is possible, and in many cases it is a perfectly reasonable course of action! The key is to understand your situation and keep your broker in the loop during the process. The more you know about your finances, and the more involved your broker is, the more successful your experience will be. 

If you have any questions about your mortgage, get in touch with us at Clinton Wilkins Mortgage Team! You can call us at (902) 482-2770 or contact us here.