When it comes to mortgages, they want to know what percentage of your income will be spent on housing costs, to ensure you can afford your future mortgage payments. This is called the gross debt service ratio (GDS), and it is based on your mortgage principal and interest, taxes, heating costs and condo fees (if applicable) divided by your income.
But lenders also want to know that you will be able to pay your mortgage in addition to all your other existing debt. To figure this out, they use your total debt service ratio (TDS). It is calculated by adding other debt obligations, such as line of credit payments, to the expenses already included in the GDS formula, and then dividing by your income.
For many home buyers, paying down a line of credit may improve their TDS. By paying off the line of credit, their debt-to-income ratio drops, and this increases the amount they can borrow on a mortgage. In other words, paying down a line of credit can increase your mortgage affordability.
In July 2021, the Canada Mortgage and Housing Corporation (CMHC) reintroduced pre-COVID underwriting practices for homeowner mortgage insurance typically required for purchases in which the borrower has less than a 20% down payment.
Specifically, CMHC requires:
- At least one of borrowers on the mortgage to have a credit score of 600 or more. The same applies to a guarantor for the borrower(s).
- A borrower’s gross debt service (GDS) ratio to be under 39%.
- A borrower’s TDS ratio to be under 44%.
The “other debt obligations” part of the formula can have an impact on first-time homebuyers or those with down payments of under 20%—specifically, an increase in TDS ratio may reduce the size of a mortgage approval. But even those with large down payments may face limits on how much they can borrow when they carry a lot of non-mortgage debt.
Watch: MoneySense – Does debt impact your mortgage application
The impact of a line of credit on mortgage affordability
When calculating a borrower’s debt service ratios, CMHC includes other debt obligations, such as revolving credit (i.e., credit card debts and lines of credit), personal loans and car loans. Those debt obligations are factored into mortgage affordability differently, depending on whether they are secured or unsecured.
According to CMHC:
For unsecured lines of credit and credit cards, factor in a monthly payment amount corresponding to no less than 3% of the outstanding balance. In determining the amount of revolving credit that should be accounted for, lenders should ensure that they make a reasonable inquiry into the background, credit history and borrowing behaviour of the prospective borrower.
For secured lines of credit, factor in an amount corresponding to at least a monthly payment on the outstanding balance amortized over 25 years using the contract rate (or the benchmark rate if contract rate is unknown). Lenders may elect to apply their own internal guidelines where the result is at least equivalent to the above
Lenders typically register a collateral charge against the property for the limit of the line of credit you were approved for, and the collateral charge could be as high as the appraised value of the property or more. This is done so you can more easily increase your borrowing in the future without having to incur legal fees.