In this blog, we are going to talk about how a client of mine was able to rearrange her finances such that she and her partner could mortgage qualify for a $400K target house in their neighborhood.
The challenge was that they had too much debt, including 2 vehicle loans, high credit card balances, line of credit and a student loan. They had been told by their bank that their debt-to-income ratio was too high, and that was the end of that meeting :/
In mortgage financing, it is important to understand that you are allowed to use no more than 44% of your provable gross income for all your consumer debts and obligations, plus the new mortgage, property taxes, and an amount for utilities. Simply put, the more debt obligations you have, the smaller your home.
This ratio of debt-to-income is called your Total Debt Service Ratio or TDSR.
In the following video segment, take a look as I demo the impact of monthly payment obligations as they relate to mortgage qualifying. It’s quite eye-opening for some.
How to Get a Mortgage With Too Much Debt
To solve the problem and mortgage qualify for their $400K dream home, my clients needed to either:
- Make more money, or.
- Reduce their monthly payments.
Clearly, making more money is not an easy nor a quick fix. Some borrowers might be tempted to bring in a parent to cosign the mortgage with them. However, while that might help you mortgage qualify, it doesn't really help you make the mortgage and other monthly payments you are obligated to make. That's where the term “house poor” comes from.
"One strategy is to reduce the amount of payments that you have, and that sometimes means some difficult decisions."
One of the easiest fixes is to look at your consumer debts and determine if there are debts that can be removed or reduced. For example, if you have a travel trailer or a boat payment, ask yourself … would you rather have the toys and continue to rent? … or would you rather have your own home?
So when borrowers say they can't mortgage qualify or the government is making it too tough to get a mortgage, also ask yourself whether you ought to share some of the blame, too. It would be great if we all had unlimited income, but that is simply not the case. To get a home, the Government of Canada has set a stress test to make sure you live within your financial means.
One of the finance tricks that the new car industry does to sell more cars is allow you to trade in your older vehicle for a new vehicle and they roll in the payout balance on your previous loan into the new car loan. What you end up with is with a high monthly payment for a vehicle that is worth less than the loan amount. That's called “negative equity” and it's a debt trap that’s difficult to get out of.
And while it may look or feel good to drive around in a brand new vehicle, with that often comes a high vehicle payment and a high auto insurance payment. Some people wonder why they never get ahead and with a couple of new vehicles in the family it's clear to see where all the household income is going. (And that leads to another problem that I run into often, which is a lack of down payment savings!)
A Solution - Buy a Used Vehicle Instead
With my clients, I asked them how attached they were to their vehicles relative to a desire to own their own home. I suggested they determine what one of their vehicles would sell for on Kijiji and what the loan balance was. She advised the car with a $600/mo payment had approximately $4,000 in negative equity. That meant that if she sold her car, she would have to write a cheque for $4,000 to make it lien-free.
My advice was then if you really want to buy a $400K home, to use a portion of their $20K in down payment money to pay off the $4K lien balance and use another $5-6K to buy a used vehicle. This would shrink their down payment savings in half to $10K, but with a $600/mo vehicle payment gone plus $150/mo avoided in new car insurance, they had $750/mo in extra cash that she could immediately start to save back into their down payment fund.
How the Story Ends
Having given up one new car and ridding themselves of one vehicle loan in order to get a home instead, her parents were impressed with the financial decision they had made, and agreed to gift (spot) them $10K to help out with her down payment. They got their debt-ratio in line, were mortgage-approved for a $400K home and within a year my clients will be able to repay her parents with the money they are saving by owning a used vehicle instead. Further, instead of paying rent they now are building equity every month by paying down their own mortgage.
So if you really want your own home, it all starts with a plan. Give us a call.
PS - it’s harder to ask your parents to help out with a home purchase when you are driving newer and nicer vehicles than they are!
PSS - there are other strategies to get your debt-to-income ratio in-line including refinancing a vehicle (5 years or newer) or consolidating credit card and line of credit debt into an amortizing loan with a lower monthly payment. Ask us.