Buying a home is a big deal.
For many people, it’s the single largest and most valuable asset they will own. A home is also an incredibly important part of daily life. It’s a place to prepare for the day, relax afterward, and spend quality time with family.
These qualities make mortgage approval a critical process. No one wants to find the right home at the right price and know they can afford it, only to be denied approval on their mortgage application.
Does a line of credit affect mortgage approval? Along with many other types of debt, a line of credit can influence the mortgage approval process. In certain situations, having or taking out a line of credit may make approval much more difficult. In others, the line of credit may not be a major obstacle to approval.
Let’s take a closer look, starting with a few basic definitions.
Understanding Lines of Credit and Mortgage Approval
What is a line of credit?
A line of credit is a specific type of loan. The Financial Consumer Agency of Canada points out the key qualities that define a line of credit:
- The loan has a pre-set limit that you can borrow up to, but not beyond.
- With the limit as the maximum, you choose when to borrow as much or as little as you want.
- The funds generally do not need to be used for any specific purpose.
- As you pay back the principal and interest, your available credit increases and you can continue to borrow against it.
Lines of credit share many similarities with credit cards. Some of the biggest differences are:
- Lines of credit don’t come with a physical card that can be used as a form of payment.
- Lines of credit can often feature lower interest rates as compared to credit cards.
There are a variety of lines of credit available in Canada, including:
- Unsecured line of credit: A line of credit that does not require you to put up collateral in exchange for approval. This helps protect your assets but can lead to higher interest rates.
- Secured line of credit: A secured line of credit requires you to use something you own as collateral. This often comes with the benefit of lower interest rates as compared to other options.
- Home Equity Line of Credit (HELOC): A HELOC uses your home as collateral, allowing you to leverage the money you’ve put into your house.
What is the mortgage approval process?
Mortgage lenders take a risk each time they issue a home loan. They can’t be certain that a borrower will pay their mortgage in full.
The mortgage approval process focuses on things like your income and credit. Mortgage lenders follow an in-depth review process to reduce the risks they face in lending large amounts of money.
As MoneySense explains, there are two main financial metrics lenders use to assess risk:
- Gross debt service ratio (GDS), which adds up all monthly costs related to the new home and divides it by your income. A GDS above 39% is a major red flag for lenders.
- Total debt service ratio (TDS), which adds up all your monthly debt and divides it by your income. The TDS limit is 44%.
How does a line of credit affect mortgage approval?
When you carry a balance on your line of credit, it will increase your TDS.
If you have generally low debt overall, this may not impact your mortgage application. However, carrying a high balance on your line of credit — or across many types of debt — could push you over the maximum limit for TDS.
In other words, debt, like money owed on a line of credit, can lead to a denial on a mortgage application. If you’re in this situation, you could pay down debt to ultimately reduce your TDS. You could also look for a less-expensive new home, which would also lower your TDS.
Does having an unused line of credit affect mortgage approval?
An unused line of credit won’t increase your TDS because you don’t actually have any debt. However, some lenders might use the line of credit's limit in their calculation, as opposed to the actual debt owed.
Does a home equity line of credit affect your mortgage?
A HELOC could have a similar impact on your mortgage application as any other line of credit.
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