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Can I afford to buy a home with credit card debt?

In an ideal world, you’ll have paid off all your debt and be completely out of the red before buying a home. But with credit card debt a reality for many (roughly 1 in 3 Canadians carry a balance month-to-month), several aspiring buyers are juggling debt while on the house hunt.

So, can you afford to purchase a home with credit card debt? The short answer is yes. But it can make the home buying process more difficult and add financial pressure to what’s arguably life’s biggest purchase.

Buying a home with credit card debt

Reasons for:

  • Get into the competitive real estate market sooner (average home prices have risen double digits year-over-year in some major Canadian cities)
  • Real estate builds equity, is a great long-term investment, and promotes forced savings
  • Both fixed and variable mortgage rates are currently at record-lows
  • Provided you diligently keep up with monthly payments and owe a relatively small balance, carrying some debt may only have a small effect on your mortgage application

Reasons against:

  • Owing credit card debt will increase your debt-service-ratio, lowering the size of the mortgage you could otherwise qualify for and hurting your buying power
  • Depending on the size of your debt – relative to your total limit – your credit score could be negatively impacted. And with a lower credit score, you won’t qualify for the best rates
  • After monthly mortgage and credit card payments, you may be overextended and find it more difficult to save for other financial goals or keep up with bills
  • At 19.99%, high-interest credit card debt can eat into your net worth and property value gains

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How credit card debt affects a mortgage application

Credit card debt can limit the amount you can borrow

Several factors are used by lenders to determine the maximum mortgage you can afford – from your income and the size of your down payment to whether or not you owe debt.

When assessing your affordability, lenders will look at two ratios: Your gross debt service (GDS) ratio and your total debt service (TDS) ratio.

The GDS ratio includes your housing expenses, such as your mortgage payment, property tax, heating costs, and 50% of your condo fees (if applicable). All of these are added up and then divided by your gross annual income.

Here’s the formula for the GDS ratio:

Mortgage payments + Property taxes + Heating costs + 50% of condo fees ÷ Annual income

If it’s less than the industry standard of 32%, your lender will be confident in your ability to pay your housing expenses.

But let’s consider how credit card debt will affect your affordability by looking at the TDS ratio. The formula for the TDS ratio takes into account any debts you owe as lenders want to ensure you can afford both your mortgage payments as well as your other monthly debt payments.

Here’s the formula for the TDS ratio:

Housing expenses + Credit card payments + Car payments + Loan expenses ÷ Annual Income

Let’s look at an example of determining your maximum affordability, both with and without credit card debt. In this example, let’s assume you earn a household income of $90,000 annually before taxes, you owe $20,000 in credit card debt, you’re making monthly payments of $600 or $7,200 a year, and you have no other loans.

According to the TDS ratio, the most you can afford for annual housing expenses is $28,800.

$28,800 + $7,200 ÷ $90,000 = 40%

But if you didn’t have any debt at all, you could afford higher housing costs while still staying under the 40% TDS threshold.

$28,800 ÷ $90,000 = 32%

One thing to keep in mind is that your GDS and TDS ratios are guidelines. If you have a good credit score and either ratio is a little higher than the standard, you may still qualify for a mortgage. To determine what you can afford, use our mortgage affordability calculator.

Your credit card debt could hurt your credit score

One of the factors your lender will use to determine your viability as a borrower is your credit score. Many factors determine your credit score, with one of the most important being your credit utilization ratio.

Your credit utilization ratio is the amount of debt you carry as a percentage of your overall credit limit. Ideally, you shouldn’t owe more than 30% of your limit as debt. For example, if you have a credit card with a $10,000 limit, you ideally shouldn’t owe more than $3,000. If your credit cards are frequently maxed out or near their limits, your credit score will go down.

Having a high credit score is important because it allows you to qualify for today’s best mortgage rates from top lenders.

Let’s say you were to purchase a $500,000 home with a 5% down payment and are able to qualify for a mortgage with a great interest rate of 1.68%. Your monthly payment would be $2,016, and according to our mortgage calculator, you would pay $110,909 in interest over the life of the mortgage.

But if your credit isn’t good, you might not qualify for the best interest rate and will have to put a larger down payment to ensure the home is still within your reach. Assuming you want to buy that same $500,000 home but only qualify for a higher mortgage rate of 3.3%, you would need to put down a higher down payment (15% would result in a monthly payment of $2,135) and pay more interest over the entire life of the mortgage ($203,734 in this scenario).

 

How to reduce your credit card debt

Whether or not you’re an aspiring home buyer, these strategies can help you pay off credit card debt faster.

Consolidate your debt

If you're carrying debt in a few different places, you may be able to consolidate it with a personal loan or line of credit. In this situation, you would use those funds to pay back your original lenders, then focus on paying back the single loan/line of credit itself. For those struggling to keep track of multiple debts, this simplifies the process by turning them all into one, making the repayment process more manageable. You may be able to negotiate for a lower interest rate, allowing you to pay off your debt faster (so long as you're committed to your goal). Plus, scheduled repayment plans for personal loans and lines of credit tend to be more flexible, giving you more time to pay them back.

The downside? If your credit score isn't great, you may have trouble being approved without a co-signer or an asset to use as collateral.

Get a balance transfer credit card

Using a balance transfer credit card can be a great way to tackle debt, providing you've got a solid repayment plan in mind.

You can transfer your existing balance over to one of these cards for a small fee (usually around 1-3% of the total) and take advantage of an ultra-low promotional interest rate, allowing you to pay off your debt much faster. Depending on the card and current offer, this can range from 0% to around 4% and last anywhere from six to ten months. Using a balance transfer credit card can be incredibly helpful in paying off existing debt, but it's important to know you can get debt-free within the promotional time period for this option to work.

Don’t just make the minimum payment (pay more)

You’ve heard it before: always pay off your credit card in full. But if that’s a financial stretch, don’t settle for making just the minimum payment.

Paying extra on top of the minimum payment – even if it’s only $50 or $100 more every month – can knock years off your debt repayment journey and help you save a ton on interest.

Make multiple credit card payments

The amount of interest you owe on a credit card is calculated based on your average daily balance – not how much you owe at the end of the month. So, by making multiple payments towards your credit card throughout the month, instead of waiting for your statement to arrive at the end of your 30-day billing cycle, you can lower your debt load on a faster schedule and effectively reduce your interest payments.

Put your cards away

If you're serious about handling your credit card debt, it's important to not be tempted to keep using your cards while you're still trying to pay them off. This can be tough to do, but a longstanding trick that seems to help many is taking them out of your wallet and putting them somewhere (a jar in the freezer has long been a popular choice) where you're unlikely to reach for them. This doesn't mean forgetting about them altogether (you still have debt to pay off, remember) but simply keeping them in an inconvenient location where you'll have more time to reconsider purchases when you become tempted.

The bottom line

If you have a good credit score and you don’t have a lot of credit card debt, you’ll be able to afford a bigger mortgage, you’ll have lower monthly costs, you’ll enjoy lower interest rates, and you’ll save money on the overall cost of your home. Buying a home in Canada while carrying credit card debt is possible but buying a home without credit card debt is much easier.

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