Debt might be a fact of life this time of year, but experts warn of long-term impacts
With the holiday shopping season shifting into high gear, many Calgarians will be reaching for their credit cards.
But those decisions about taking on debt to put smiles on faces can be the unwelcome gift that keeps on giving, putting the squeeze on your ability to qualify for your first — or next — mortgage, say experts.
“Where people sometimes make a big mistake is they don’t realize how much of an impact their debt has,” said mortgage broker Joe Jacobs, president of Mortgage Connection Inc. in Calgary.
“If you have a monthly payment of $420 in your outside (non-mortgage) debts, that’s $75,000 worth of mortgage financing you can’t qualify for.”
It’s a crunch many Canadians are facing. Total household debt is growing nationwide.
The study Indebtedness of Canadian Households, published earlier this year by the Canada Mortgage & Housing Corp., (CMHC) shows the ratio of household debt to disposable income has almost doubled since 1990. And 89 per cent of that increase is secured by real estate in the form of mortgages and home equity lines of credit.
There are two sides to that coin: owning a higher-priced home means more debt, but it also means higher net worth, the CMHC study points out.
Yet achieving that increased net worth and making home ownership a reality means qualifying for a mortgage. That’s where your total debt service ratio — the potential principal, interest, taxes, condo fees (if any) and utilities on your dream home, plus all your monthly loan and credit payments, as a percentage of your gross income — is crucial.
“Credit is just a tool, and like all tools you have to learn how to operate it or bad things can happen.”
“Typically, lenders don’t want to see that go over 40 per cent,” said Scott Hannah, president and CEO of the non-profit Credit Counselling Society of Canada.
It’s a simple concept: the more you owe, the less you can afford.
“Credit is just a tool, and like all tools you have to learn how to operate it or bad things can happen,” Hannah said. “What is a real concern is the amount of consumer debt people are carrying in the form of credit cards and car loans.”
Jacobs adds unsecured lines of credit to that list, noting the monthly burden of a credit line is calculated at three per cent of the balance owing, even if your minimum payment is much less. So owing $15,000 on a line of credit is, on paper, a $450 monthly hit — “a real killer,” he said.
Unlike a mortgage, these debts are generally tied to things that will not increase your net worth, and, in fact, hamper your ability to build wealth in the form of real estate. Jacobs said car loans are a classic example.
“We don’t always know what the housing market’s going to do, but we do know that your car is worth less than you paid for it the minute you drive it away,” he said.
“When your long-term debt is tied up in a depreciating asset, that’s not the wisest move.”
Hannah said he’s seen numerous cases where people with decent incomes cannot get a mortgage because of consumer debt. And federal rules that came into effect in October will push more people into that category, since all borrowers now have to qualify at the lender’s five-year projected interest rate.
Jacobs and Hannah both agree the best way to make sure you can still qualify for the mortgage you want is to decrease or eliminate your other debts.
“Debt reduction is more important now that you have your buying power reduced by the new regulations,” Jacobs said.
For people seeking their first mortgages, Hannah has a few words of advice: “Don’t ask, ‘how big of a mortgage can I get?’ instead of ‘what’s a comfortable amount that I can afford?’ That’s a big mistake people make.”
As for those putting those holiday bills on your credit card, try to avoid the temptation, Jacobs said.
“It’s a tough thing from a family standpoint, but you’ve got to realize what the cost really is,” he said. “Credit cards should be a convenience, not something that consumers use to borrow.”