Credit capacity: Can you afford this mortgage?

When deciding whether to approve your mortgage, besides looking at your credit history, lenders also want to know if you'll be able to afford your mortgage payments.

This page:

  • Explains what factors make up your credit capacity

  • Describes how these factors affect your chances for approval

Now that we've covered credit history, the following pages focus on your credit capacity and how lenders will look at the mortgage collateral.

The second part of this guide examines the rest of the decisions you'll have to make when choosing your mortgage. Refer to the table of contents if you're looking for specific information.

Credit capacity: income and debt.

Credit capacity is the mortgage phrase for how large a mortgage your lender thinks you can handle. Your income, savings, and the amount of debt you already carry are the key players.

Lenders use a couple of figures, the "front end," or housing expense ratio, and the "back end," or debt-to-income ratio, to help them figure out how much in monthly mortgage payments you can afford.

  • the front end ratio is a calculation of how much of your total pre-tax income will go toward mortgage payments, and

  • the back end ratio is a calculation of how much of your total pre-tax income will go toward all your debt obligations.

In general, lenders don't like to fund mortgages with a higher than 28% front end ratio or higher than 36% back end ratio.

Putting too much of your income toward housing suggests that you may be spreading yourself thin. Such borrowers may have trouble keeping up in payments. This isn't to say lenders won't approve a mortgage that exceeds those guidelines, it just becomes more unlikely.

(These ratios are a big reason that 30-year mortgages are more popular than 15-year mortgages, even though the shorter-term loans are so much cheaper. The high monthly payments on 15-year mortgages simply make these income ratios too high.)

A question of credit

Clearly, your total debt factors into your ratios very heavily. But the type of debt can have almost as much influence as the size of debt.

Owing a lot of money on revolving debt, like credit cards, can make lenders especially wary. (It can be seen as a propensity for financial over-extension.)

But carrying some debt can actually help your profile. Lenders like to see that you are willing to take on financial responsibilities and manage them wisely. They just don't want to see too much debt, or debt taken on too quickly.

And if you must . . .

Some borrowers may feel that lenders are underestimating their ability to manage mortgage debt. (Maybe you have good reason to believe that your income is increasing in the near future.)

Keep in mind, however, that lenders use these figures for a reason. It really can be difficult to carry much more debt and you should always avoid overextending yourself.

And let's not forget about that other financial factor: your savings. The last part of your ability to buy is decided by the collateral you can offer.



Next: Your collateral can make all the difference.

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