How much house can you afford?
Once you've decided to forego your renting ways and
start paying off own mortgage instead of someone else's, the big
question you must ask yourself is how much house can you afford?
Or, more to the point, how big a mortgage can you
It's a deceptively easy question. After all, you can
afford however much your bank or private lender qualifies you for,
right? They run your financial information and credit history through
so many tests that they know best when it comes to figuring out
the magic number, right?
Wrong. When it comes to how much house you can afford,
you are the expert. So, before you sign up for the maximum mortgage
you qualify for, which may be outside your comfort level, consider
the following advice culled from recent home buyers on how to determine
what you can afford.
Don't rely on rent as a guideline
Many first-time home buyers make the mistake of assuming they can
afford monthly mortgage payments as big as their current rent payments.
And while it makes a certain amount of sense, that calculation overlooks
some major factors.
"I often thought a safe monthly mortgage payment
would be roughly equivalent to our rent," says Alex Beckett,
of Toronto, who bought his first house three years ago.
"Unfortunately, property taxes and all those
other ownership-related costs can add up to about the equivalent
of three or more months of rent a year in Toronto."
As a renter, you never have to worry about paying
extra for property taxes, which are incorporated into your rent.
But for homeowners, they can easily cost between a few hundred and
a few thousand dollars a year depending on where you live.
If your current rent also includes the cost of utilities,
such as gas and hydro, you'll also have to figure those expenses
into the monthly costs of owning a home. Most experts also recommend
keeping money aside for emergency repairs, since homeowners can't
call the landlord when something breaks.
You'll also want to figure in the cost of mortgage
loan insurance, especially if you have a high-ratio mortgage. So,
there are many new costs to consider that mean your current rent
payments may not be a good guideline to follow.
"If your current rent approximates your comfort
level, I think you should aim a little lower for a monthly mortgage
payment," says Beckett.
There is a more precise rule of thumb for determining
how big a mortgage you can afford-two, in fact. You need to know
your total monthly debt load and your total monthly housing costs
to figure out an affordable maximum mortgage payment.
Keep your debts around 40 percent
When Heather Keam, of Burford, Ont., was house shopping last year,
she and her husband calculated how much they could afford by looking
at their monthly income.
"The way we decided how much we could afford
was based on our pay cheques," says Keam. "We did not
want our mortgage payments to be more than 40 percent of one pay
She says sticking to that target was especially important
because they were looking for a fixer-upper they could renovate
themselves and knew they'd need to invest money in right away.
Keam and her husband were right on track with the
experts' advice. As a general rule of thumb, the Canada Housing
and Mortgage Corporation (CMHC) uses two guidelines for home buyers
who put down less than 25 percent of the home's purchase price and
so need a high-ratio mortgage.
The first concerns debt. Your maximum monthly debt
load, also known as your total debt service (TDS), should not exceed
40 percent of your gross monthly income. In other words, the combined
amount you pay in housing costs, car loans, personal loans and credit
card debt shouldn't be more than 40 percent of your pretax income.
To calculate your current TDS, divide your monthly
debts by your monthly pretax income and multiply by 100. To determine
what lenders will consider your maximum allowable debt, multiply
your gross annual salary by 0.40 and then divide by 12.
Cap your housing expenses at
The other guideline concerns your housing expenses. Your maximum
monthly home-related expenses-or gross debt service (GDS)-should
not exceed 32 percent of your gross monthly household income.
That means your monthly mortgage payment, property
taxes, insurance payments and heating costs shouldn't be more than
32 percent of your monthly pretax income.
To calculate your current GDS, divide your total monthly
housing expenses by your gross monthly income and multiply by 100.
To determine what lenders will consider your maximum allowable housing
expenses, multiply your gross annual income by 0.32 and then divide
So, for example, if you have a gross annual household
income of $45,000, your maximum allowable monthly mortgage payment-including
the cost of heating-would be $1,200. Your maximum allowable debt
load would be $1,500.
Keep in mind these guidelines are for high-ratio mortgages.
Lenders will be more flexible for home buyers with larger down payments
and conventional mortgages.
Think about the future
Beckett says home buyers would do well to consider their future
carefully before choosing a mortgage. Because big life changes can
spell big trouble when it comes to making your payments.
"Any couple planning to have kids should consider
what kind of payment they could make with one of them on leave for
a year," he says. "The benefits are much better than they
used to be, but a lot of the employment insurance benefits get clawed
back if your annual income exceeds a certain amount. That can be
a very unpleasant surprise."
So, instead of taking the maximum mortgage for which
you qualify, it might make more sense to settle for something a
bit cheaper in case you expect to generate less household income
in the future.
Once you've had a chance to pull together your financial
information and think about how much house you want, find out how
much house you can afford with our mortgage affordability calculator.
Then, check out the going mortgage rates for your area here.
Gillespie is a freelance writer and editor based in Simcoe,