How Different Types of Debt Impact Your Mortgage Approval

Securing a mortgage is one of the most significant financial steps in life, and your existing debt plays a crucial role in the approval process. Lenders carefully evaluate the type, amount, and repayment history of your debts to determine your risk level and overall ability to manage a mortgage. Understanding how each type of debt impacts your application allows you to prepare strategically and improve your chances of approval.

The Importance of Debt-to-Income Ratio in Mortgage Approval

Before reviewing specific types of debt, it’s essential to understand the debt-to-income (DTI) ratio. This ratio compares your monthly debt obligations to your gross monthly income.

• Gross Debt Service (GDS): Includes mortgage payments, property taxes, heating, and half of condo fees.
• Total Debt Service (TDS): Includes GDS plus all other debt payments (credit cards, car loans, lines of credit, student loans, etc.).

Most lenders prefer a TDS of no more than 44%, although stricter lenders may require lower thresholds.

Credit Card Debt and Its Influence

High credit card balances, especially if they are close to the credit limit, raise red flags for lenders. Even if you pay on time, high utilization rates negatively impact your credit score.

• Key factors lenders consider:
• Credit utilization (should ideally be below 30%).
• History of on-time payments.
• Frequency of carrying a balance month-to-month.

Reducing credit card balances before applying can significantly improve both your credit score and your perceived affordability.

Car Loans and Lease Payments

Auto financing is a fixed obligation that directly reduces your borrowing power.

• Car loans: Large, long-term car loans increase your monthly obligations, raising your TDS ratio.
• Leases: Even though leases may have lower monthly payments, they still count fully against your DTI.

Lenders often reduce the size of mortgage approval by the full amount of your auto payment. For example, a $600/month car loan could reduce your mortgage borrowing capacity by tens of thousands of dollars.

Student Loans and Government-Assisted Debt

Student loans are unique because they often come with deferred repayment periods or income-based repayment plans.

• If you are in repayment, the monthly obligation is included in TDS.
• If deferred, lenders may still calculate an estimated payment (often 1% of the balance) to include in your debt obligations.

Consistently paying student loans on time, however, can help build a strong credit history, which benefits your mortgage application.

Personal Loans and Lines of Credit

Personal loans with fixed terms are easier for lenders to assess since they have a clear repayment schedule. Lines of credit, however, can be riskier because they remain open and available for borrowing.

• Personal loan impact: Reduces borrowing power but demonstrates repayment discipline if managed well.
• Line of credit impact: Even unused lines may be considered, since lenders assume you could borrow against them at any time.

Paying down personal debt before applying for a mortgage improves both your affordability and your risk profile.

Business Debt and Self-Employment Considerations

If you are self-employed and personally liable for business debt, lenders factor those obligations into your DTI. Even when loans are technically for business purposes, if they appear on your personal credit bureau, they impact your approval.

• Ensure your accountant prepares clear financials separating business from personal obligations.
• Consider restructuring debt so it remains in the business name only.

Medical Debt and Collections

In Canada, medical expenses are typically covered under provincial healthcare, but medical-related debts, such as unpaid private insurance or dental bills, can appear in collections.

• Collections severely damage your credit score.
• Even small amounts in collections can raise red flags for lenders.

Resolving collections prior to application is critical to avoid mortgage denial.

Payday Loans and High-Interest Borrowing

Payday loans are seen as a strong indicator of financial distress.

• They suggest cash-flow problems and poor money management.
• Lenders treat them as a major risk factor, often lowering your approval odds significantly.

Avoid payday loans entirely when preparing for mortgage financing.

Secured vs. Unsecured Debt: What Lenders Prefer

• Secured debt (car loans, home equity lines of credit): Backed by collateral, considered less risky.
• Unsecured debt (credit cards, personal loans): Higher interest, riskier, and more damaging to mortgage approval.

While both types reduce borrowing power, unsecured debt typically has a greater negative impact.

Strategies to Improve Mortgage Approval Odds

1. Pay down high-interest debt first – Focus on credit cards and payday loans.
2. Consolidate debt – A single lower-payment consolidation loan can improve your DTI ratio.
3. Avoid new debt before applying – Lenders scrutinize recent borrowing activity.
4. Maintain on-time payments – A strong payment history outweighs temporary high balances.
5. Check credit reports regularly – Dispute errors and clear inaccuracies early.

Final Thoughts

Debt plays a central role in determining mortgage approval. Credit card utilization, auto financing, student loans, and personal debt all shape the lender’s perception of your ability to manage future mortgage payments. By reducing high-risk debt, maintaining strong credit habits, and managing your debt-to-income ratio, you strengthen your application and increase your chances of securing favorable mortgage terms.