Purchasing your first home or upgrading your current one is a really exciting decision to make but it’s also one of the most financially stressful things you can do. It can seem like there are a thousand papers to sign and tasks to accomplish. The fee and extra costs start to pile up before your eyes and it can often seem like you’ll never actually be able to afford the home of your dreams. This is why it’s important that you take into account all of the extra costs and fees before you decide on what house you want to buy. Determining exactly how much mortgage you can afford is the number one most important decision you can make when it comes to purchasing a home for you and your family.
There are a few factors that need to be taken into account when determining the amount of debt you can afford to take on. These factors include:
- Your total household income
- Your personal monthly expenses (car payments, bills, credit card payments)
- All the expenses associated with owning a property (property taxes, utilities, condo fees)
- Your current cash resources that can be put towards the house
We understand that this might all be really overwhelming and that once you start crunching the numbers a new home can seem out of reach. Purchasing a property is expensive no matter how you look at it. Figuring out your affordability and creating a budget to help you pick the best home for your money will help you stay on track and not get in over your head.
How to Evaluate Your Own Affordability
Everyone’s income is different and everyone’s budget is different so it’s important that you calculate and evaluate how much mortgage you can afford solely based on you and your financial situation. Your mortgage lender won’t approve you for a mortgage that you technically can’t afford, but they will approve you for a higher mortgage than you’re comfortable with. Our number one piece of advice to future homeowners is to decide on your own how much mortgage you are comfortable with and can actually afford to make payments on and still live the life you want. Here are a few questions to ask yourself:
- Is a larger house worth the extra monthly cost to you?
- Would you rather have more money to go on trips and buy the things you want?
- Is being able to save more for a rainy day very important to you? More important than a bigger house?
Trusting your lender is important but you need to take responsibility for your debts and make sure you don’t put yourself into a situation where you might not be able to afford the life style you’ve created.
How Your Lender Determines Your Affordability
Your lender will look at two “rules”, which take into account your household income, monthly housing costs and current debt load, to decide the amount of mortgage you can afford to take on.
The first rule is that your monthly housing costs cannot exceed 32% of your gross household monthly income. Your monthly housing costs include your potential mortgage payment, taxes and any heating expenses you might have. So all of those expenses added up cannot surpass 32% of your gross income in one month.
The second rule is that your total monthly debt to income ratio typically cannot exceed 40% of your gross monthly income. Your monthly debt typically includes your housing costs, credit cards, car payments and any other debts you might have.
In Canada the minimum down payment for a mortgage is 5%. While 5% is a perfectly ok down payment, it’s always best to put down as much as you can afford to. The higher your down payment is the less you’ll have left to pay off. In Canada if your down payment is less than 20% you’ll be required to purchase mortgage default insurance because your mortgage will be seen as a high-ratio mortgage.
Another factor that will help you determine how much mortgage you can afford is the liquid cash you have available to spend. This cash is typically used to put towards your down payment to cover all your closing costs.
The Bottom Line
The bottom line is that you shouldn’t take on any debt that you aren’t completely comfortable with paying off in a reasonable time. A mortgage is a good kind of debt and a home is an investment in your family and your future. Just make sure you follow the steps above, determine how much you can actually afford and don’t take on more than you can handle.