Can You Get A Mortgage With Outstanding Debt?
If you're applying for a new mortgage or looking to remortgage to get a cheaper deal, one of the most common misconceptions is that having other kinds of debt will significantly affect your chances of being accepted.
Outstanding debt will affect your ability to get a mortgage in credit risk and affordability assessments. Having debt will not stop you from being accepted but the type and amount of debt relative to income are all as important as the total debt amount.
Read on to understand exactly how having outstanding debt affects your chances of getting a mortgage.
How outstanding debt affects mortgage eligibility
Having outstanding debt is definitely a factor in whether or not you will be able to get a mortgage, but it is not as big a factor as some people think.
There are a large number of different factors that affect whether your mortgage application will be accepted. Aside from various fraud and anti-money laundering checks, a mortgage application chiefly focuses on 3 key assessments:
- Your credit profile
- Affordability
- Property valuation
The property valuation question is something that debt won't affect in any way so I won't cover it here, but the other two assessments above are critical and any outstanding debt you have will play into both of these, albeit in different ways.
Unfortunately when you look up exactly how debt affects eligibility, there's a lot of really poor advice out there, mostly from people who have never worked in the industry so I wanted to clear up a big myth.
Why you shouldn't use the debt to income ratio
Almost every other article on this topic will tell you that the most important factor is the debt to income ratio - the ratio of the monthly income you bring in as an applicant or household to the monthly repayments on your debt.
The reason this factor exists is because mortgage companies have to provide a simple approximation for various mortgage advisors and real estate agents to be able to quickly figure out if the customer has a decent chance of being accepted.
Debt to income ratio will usually not be used in the actual credit scoring process
The truth is that this specific measure will not be used in the actual credit scoring process by the mortgage lender (or at least the dozens of scorecards that I have worked on do not use it).
Sure - some variables that are similar are used like a measure of your indebtedness (for example the Consumer Indebtedness Index that is provided by Experian), but these are far more sophisticated in how they are worked out.
Also, the debt to income ratio fails to take into account the absolute magnitude of someone's income and debt. For example having a 50% debt to income ratio on an income of £100,000 per month is very different to having a 50% ratio on an income of £1,500 per month in the eyes of the lender.
How debt affects your credit score for a mortgage application
The first consideration of how debt affects your mortgage application will be whether you will be able to pass the credit assessment.
The credit assessment works slightly differently in the UK and the United States which is important if you are based in one of these, but see some information that relates to the other country.
Mortgage credit eligibility in the United States
In the US, credit scoring is generally a lot more centralised with the FICO score being a crucial component of any credit assessment with lenders using that score as a critical measure of someone's credit worthiness.
Factors relating to outstanding debt will comprise about 30% of the FICO score and another 30% on top will be based on indirect variables that are linked to your debt total, however having a higher income will significantly depress some of these factors - having $20,000 debt on an annual salary of $200,000 is not a big deal, but it is if you're only earning $40,000.
Mortgage credit eligibility in the United Kingdom
In the UK, the situation is different. Every lender has their own proprietary way of assessing credit and these differ greatly between different providers.
In general though, it will be the total amount of debt you have that is assessed, not your monthly repayments. Monthly repayments will be important in the affordability calculation (see below).
As a result of every lender having their own process, there is no hard and fast rule here, but the less debt you have, the better your chances will be as long as you have a good and active credit history (i.e. you at least have a current credit card).
Not all kinds of debt are created equal, however so make sure you pay attention to what sort of debts you have.
| Debt Type | Effect |
|---|---|
| Credit Cards | One of the worse types of debt in the eyes of mortgage lenders as it shows signs of unsustainable spending. If you have revolving credit card debt, the total credit limits may also be a factor as your debt total could increase if you spend more. |
| Loans | Fixed term loans are a better type of debt as repayment amounts are fixed and you can't increase your debt without applying for a new loan. |
| Car Loans and Finance | Various different types of car financing schemes work in different ways but are largely considered to be the same as loans when processing mortgage applications. |
| Buy Now, Pay Later and Catalogue debt | Depending on the type and term, this will either fall into the same category as regular loans or a separate short-term/high risk debt category - this is something you'd ideally not want on your credit profile. |
| Student Loans | No effect at all in the UK as these are not actual loans but a form of graduate taxation. They will impact affordability, however. |
Outstanding debt in the mortgage affordability calculation
Affordability is where outstanding debt becomes a very important factor in assessing whether you can get a mortgage.
The Affordability Assessment is essentially a way for the lender to understand whether you can actually reasonably meet the required monthly repayments for the mortgage.
This is different to the credit profile and depending on where you live, it may be legally mandated for the affordability calculation to be done completely separately from the credit risk assessment.
You may have perfect credit and a great credit score, but if the mortgage company doesn't think you'll actually be able to afford the monthly repayments, your excellent credit profile won't make any difference.
Although this check is done differently by different providers, the way it typically works is to create a relatively straight-forward calculation of your monthly incomings minus your monthly outgoings.
On the incoming side, the mortgage lender will take your salary & any other regular sources of income (all after tax and deductions). In the case of more than one applicant, the usual practice is to take 100% of the primary applicant's salary and reduce the second income by a percentage.
Otherwise the mortgage company carries a greater risk as there is double the chance of things going wrong if either of the two people lose their job, for example.
How debt affects your outgoings
On the outgoings, there are typically 3 separate parts - debt repayments, fixed expenditure and general spend.
Fixed expenditure will come from the specific questions the lender asks about things like child care costs, regular bills and other things you pay a fixed amount for every month.
General spend is usually calculated by the lender based on their assumptions and where you live - this will cover things like buying clothes and food. Even if you answer those questions on the form, usually the lender will override them with their own assessment anyway.
With debt, the lender will take the current monthly repayments on all your debts as a minimum and verify these with your credit bureau data.
However, as I mentioned in the table above, this won't usually be the end of the calculation. The lender will typically account for the possibility of your credit card debt going up so having a lot of credit cards with high limits may be a factor.
If you live in the UK, they may also account for your debt interest to increase - especially if some of it is linked to the Bank of England Base Rate. This is something that doesn't apply in the US due to differences in legislation.
The result of the mortgage affordability calculation
At the end of the calculation, the mortgage lender will compare the amount of money remaining after subtracting your total living costs from your income.
Depending on how they calculated your costs, they may also reduce the remaining amount to provide a small buffer allowing for fluctuations in some of your costs (e.g. heating bills being higher in the winter).
At that point, if the monthly payment on your proposed mortgage is less than the calculated number, you should pass the affordability assessment.
Conclusion
Debt is an important factor in whether you will get a mortgage, but is isn't the most important factor and the way it impacts eligibility is not as straight-forward as some people will say.
Having less debt will always be better for qualifying for a mortgage so if you have a way of repaying some of your debts before making the application, that may be something worth looking into as long as you still have enough money left for the deposit, taxes and fees.
However it is also important to remember that debt is a relatively common thing and just having debt alone will not preclude you from getting a mortgage.
The key thing is to understand exactly what effect the debt will have on your eligibility and plan accordingly.
