It doesn’t take much to get carried away with all of the different mortgage options that are available in Canada today. If you’ve found yourself wondering, ‘Can I afford a mortgage?' or 'How much can I afford?' or 'What kind of mortgage can I afford?' then you know this firsthand. The good news is that there are plenty of tools available to assist you in understanding affordability criteria, utilizing online mortgage calculators, and getting a mortgage that you can afford. Here are some things you should be scrutinizing when you’re looking to purchase your first home that will help you determine how much home you can afford to buy.
Debt to income ratio
When applying to a lender to get a mortgage, they will use a debt to income ratio – otherwise known as a mortgage to income ratio – in order to establish how much you can afford in mortgage payments. A debt to income ratio is the percentage of your income that goes towards paying debts, and it’s divided into two categories.
The first category is a Gross Debt Service ratio (GDS), which divides your housing expenses by your income. Housing expenses are known as PITH: principal and interest (mortgage payment), taxes, and heating costs. If you’re buying a condo, then you’ll also need to include half of your condo fees.
The second category is a Total Debt Service ratio (TDS), which divides your housing expenses plus your recurring debt by your income. Recurring debt can be classified as credit card payments, car payments, and other loans.
The only difference between your GDS and the TDS is that your TDS includes recurring debt. From a borrower’s perspective, the TDS is more important since it will demonstrate whether you can afford the monthly payment in addition to all of your debt. But from a lender’s perspective, both GDS and TDS are equally important when being qualified for a mortgage.
When qualifying for a mortgage, the lender generally looks at a debt to income ratio of 35/42. The first percentage is your GDS, and the second is your TDS. As long as your GDS and TDS figures are below 35 per cent and 42 per cent respectively, you should be able to make your monthly payments.
Online mortgage calculators
Online mortgage calculators are automated tools that help you determine the mortgage you may be qualified for, as well as the financial consequences of mortgage variables including loan amount, interest rate, number of payments, and monthly payment amount.
Online calculators are a dime a dozen. Mortgage payment calculators are most easily found, although just as important are affordability calculators.
“In general, online calculators are a great place to go to get a high level understanding of the mortgage amount that you may qualify for, what mortgage payments will be and how various mortgage options can benefit you,” says John M. Turner, director of product and program development at Bank of Montreal.
When shopping for a mortgage, it’s a good idea to play around with the calculators and input different numbers to see how they affect your bottom line. The various options available may affect your monthly mortgage payment, though some not as drastically as you might think. Turner suggests sitting down with a mortgage professional and based on your particular situation, the two of you can build a mortgage and a plan that meets your needs.
“The interest rate and amortization are the biggest options that a customer can customize at the outset that can make a big difference in payments,” says Turner. “Generally speaking, interest rates for open mortgages are higher than closed mortgages and variable interest rates are lower than fixed rates.”
Something to note: some of the online affordability calculators will automatically bump up the down payment amount that you enter in order to meet the 5 per cent minimum, as opposed to lowering the approved value of the home to match that figure. Read the results carefully. And of course, the amount that the calculator predicts may be more or less when you actually meet with and are qualified by a lender.
If all of your calculations add up to the fact that you can’t afford a mortgage at the moment, that’s okay – it’s better to know now than after you’ve fallen in love with the home of your dreams! Increase your savings by automatically paying yourself first and put it into a separate account that’s only to be used for your home purchase. Or, if your income is stretched so tight that you can’t afford to save any more, rethink your strategy: what about a semi-detached home instead of a stand-alone home? What about moving to a more affordable location? What about freelancing to gain some extra income? There are so many factors that can change your monthly figures, so make sure to explore all of your options. There are also online calculators that will tell you how much you need to save on a monthly basis in order to afford a home by a certain period of time, taking into account a particular rate of return.
What else is there?
Calculations are only based on the information that you enter, so if you don’t know your monthly expenditures, they’ll be fairly useless. Getting an accurate representation of your financial situation requires you to track your household spending for a few months. It can be rather tedious, but doing so will show you where all of your money is going and how much will be left in your budget once you get a mortgage. You’ll want to ensure that there’s enough room in that budget for all of the ongoing costs of owning a home, such as taxes, maintenance, home insurance, and repairs. Spoiler alert: those prices generally do not decrease over time!
Another thing to keep in mind is the additional costs of buying a home. The largest of these will probably be the down payment. The minimum down payment amount is 5 per cent on the purchase price of a home up to $500,000, with 10 per cent required for any amount over $500,000 up to $1,000,000. The majority of Canadians have a down payment between 5 per cent and 20 per cent, which means that most home owners pay for mortgage default insurance. The CMHC Mortgage Loan Insurance premium is calculated as a percentage of the loan and is based on the size of your down payment. The higher the percentage of the total house price/value that you borrow, the higher percentage you will pay in insurance premiums.
Apart from your down payment and mortgage insurance, there are other fees that come along with purchasing a home, known as closing costs. These may include a deposit, a home inspection, lawyer or notary fees, and land transfer taxes, and there are also the inevitable moving expenses and fees for cable, telephone and Internet hookup.
Once you’ve given yourself the green light to move forward with a home purchase and your lender has approved your loan, it’s time to celebrate! Before popping open the bottle of champagne and signing those papers, however, ask yourself whether or not you really need the entire amount for which you’ve been approved. Chances are, the answer is no, and just because you qualify for a large mortgage doesn’t mean you should use it all. The larger the mortgage, the higher the monthly payment, and if you can’t afford those payments you could end up in arrears and even foreclosure. If you give yourself cushions throughout the process, you’ll not only be able to afford your mortgage, but any other costs that come up along the way – because they always do!
Are you looking to invest in property? If you like, we can get one of our mortgage experts to tell you exactly how much you can afford to borrow, which is the best mortgage for you or how much they could save you right now if you have an existing mortgage. Click here to get help choosing the best mortgage rate