Mortgage affordability explained

By Ericka Pingol

Whether you’re a budding investor or a first-time homebuyer, you have to understand what mortgage affordability is. After all, it’s the cornerstone of your home loan application.

Affordability is based on your household income, monthly expenses, and expenses related to owning a house. Lenders also look at two ratios to determine how much you may borrow. These two ratios are:

  • Gross Debt Service (GDS) ratio. This is the percentage of your monthly household income that covers your housing costs. It should be at or under 35%.

This is computed using the following equation:

= Mortgage principal and interest + taxes + heating expenses / Annual income

  • Total Debt Service (TDS) ratio. This is the percentage of your monthly household income, covering your housing costs and other debts. It should be at or under 42%.

This is computed using the following equation:

= Housing expenses + credit card interest + other loans / Annual income

Note that while the industry guideline says your GDS ratio should be at or under 35% and your TDS to be at or under 42%, you may be able to exceed these limits if you have a steady income and good credit.

A lender may also consider other factors and will load your existing loans by a buffer and account for all your incomes.

To calculate your mortgage affordability, you may need to provide the following information:

  • Annual income before tax
  • Co-applicant income before tax
  • Monthly living costs (property tax, condo fees, heating costs)
  • Monthly debt payments
  • Home type
  • Province
  • Amortization period
  • Mortgage r ate
  • Mortgage type
  • Whether you are a first-time home buyer or not

Sample computation:

Annual income before tax

 

$70,000

Monthly living costs

$590

Monthly debt payments

$400

Home type

House

Province

Ontario

Mortgage rate

3.35%

Mortgage type

 

Fixed, 5 years

Amortization period

 

30 years

First-time home buyer?

Yes

Estimated affordability

$310,356

For example, you would like to apply for a mortgage yourself, and you earn $70,000 annually, before tax. Your monthly living costs and debt payments amount to $990. You live in a house in Ontario. Your mortgage rate is 3.35% for a fixed-rate for five years, with a 30-year amortization period. You are also a first-time homebuyer.

This means your affordability may be up to $310,356 of your home purchase price. However, this is only an estimate and you need to consult your lender to get the exact amount you can borrow.

If you would like to get a rough idea of how much you can afford for a house, use our Mortgage Affordability calculator.

Factors affecting your affordability

Many factors may affect how much a lender can let you borrow. Some of these are:

  • Your credit history. Your credit history plays a huge role in determining how much you can afford for a mortgage. If you can prove that you are a reliable and responsible borrower who meets their financial obligation on time, it could improve your affordability. However, if your credit history is tarnished by missed bills and credit card payments, it may work against you.

Before going to a lender, get a copy of your credit history and see if there are any problems you can address before looking for financing. You may get a credit report using national credit reporting agencies such as Equifax and TransUnion.

To get your credit report history, you may need to provide your full name, address, date of birth, previous address, and/or driver’s license number. You may also be asked to provide your Social Insurance Number and/or credit card number to confirm your identity.

  • Your expenses. Household living expenses may take as much as half of your net salary. These expenses may include the cost of your home, utilities, food, clothing, health insurance, and transportation.

A lender will take all of these into account when assessing your affordability. It may be a good idea to take a closer look at your living expenses to see how repayments will fit in.

Use the Canada Mortgage and Housing Corporation’s worksheet to determine your household budget.

  • Your records. Your financial records like your salary slips will affect your mortgage affordability. These records support your application with proofs of any bonuses or overtime pay you regularly receive.

Some of the documents you may need to submit to your lender to show your financial records are:

    • Tax returns
    • Pay stubs, W-2s, other proof of income
    • Bank statements
    • Proof of assets
    • Credit history
    • Gift letters
    • Renting history
  • Loan type. The type of loan you are applying for vastly affect the loan amount you can afford. Lenders may determine your repayment capacity at an interest rate that is approximately 1.5% higher than the rate at which the loan is offered.

Consider consulting an expert, such as a mortgage broker, who could help you find a loan that fits your financial situation. A broker has access to a range of home loan products through a panel of lenders he or she is accredited with.

To find a mortgage broker near you, use our Find a Mortgage Broker page.

  • Your down payment. The amount of your down payment greatly affects your affordability. The larger the amount you have saved for a down payment, the easier it may be to obtain financing and increase affordability.

Lenders like to see that you can save money over some time. Generally, most lenders require a 5% “genuine savings” for your down payment. In general, you need the following amount for a deposit:

  • If your desired house costs up to $500,000, the minimum down payment is 5%
  • If you want a house amounting to more than $500,000 but less than $1 million, the minimum down payment is 5% of the first $500,000 plus 10% of the remaining balance
  • If you want a home that costs $1 million and above, the minimum down payment is 20%

Some of the steps you may consider taking to save more for a down payment are:

  • Reduce your debts. Paying off your debts may help you save for a down payment faster. Consider paying off high-interest debts such as credit cards so you may be able to keep a little more for your deposit.
  • Cut your expenses. You may trim your expenses by preparing food at home more frequently instead of eating out, or cutting back on movie dates. The money you save from doing these changes may go to your home down payment fund instead.
  • Find a second source of income. Making a bit of extra cash on the side may help you save a lot faster. For example, consider some of your hobbies and see if you can make a profit out of them.

If you are looking to buy a home to live in or as an investment property, you should always consider your affordability. By having a clue of what you can afford, you can adjust your expectations and narrow your searches. A professional may be able to help you in your search for the best home loan that fits your finances.

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