How Much Can You Afford?
Before you begin shopping for a home, it’s important to know how much you can afford to spend on homeownership. You will want to plan ahead for the various expenses related to homeownership. In addition to purchasing the home, other significant expenses will include heating, property taxes, home maintenance and renovation as required. Two simple rules can help you figure out how much you can realistically pay for a home. You must understand these rules to understand if you will be able to get a mortgage.
Affordability Rule 1:
The first rule is that your monthly housing costs shouldn’t be more than 32% of your gross monthly income. Housing costs include your monthly mortgage payments (principal and interest), property taxes and heating expenses. This is known as PITH for short — Principal, Interest, Taxes and Heating.
Lenders add up your housing costs and figure out what percentage they are of your gross monthly income. This figure is called your Gross Debt Service (GDS) ratio. To be considered for a mortgage, your GDS should be 32% or less of your gross household monthly income.
Affordability Rule 2:
The second rule is that your entire monthly debt load should not be more than 40% of your gross monthly income. Your entire monthly debt load includes your housing costs (PITH) plus all your other debt payments (car loans or leases, credit card payments, lines of credit payments, etc.). You have calculated these on the Monthly Debt Payments form. This figure is called your Total Debt Service (TDS) ratio.
Get a Mortgage Pre-Approval:
I will not take you shopping before you have been pre-approved. There is no sense in shopping for homes if you are not sure what the bank/lender is willing to lend you. It is a waste of your time, and mine, to shop without a pre-approval. A lender will look at your finances and figure the amount of mortgage you can afford. Then the lender will give you a written confirmation, or certificate, for a fixed interest rate. This confirmation will be good for a specific period of time. A pre-approved mortgage is not a guarantee of being approved for the mortgage loan.
Figure Out the Up-front Costs
There are many up-front costs when you buy a home. Early planning will help make sure things go smoothly.
A down payment is the part of the home price that does not come from the mortgage loan. The down payment comes from your own money. You can buy your home with a minimum down payment of 5%, if you have mortgage loan insurance (read below) from CMHC. You need a down payment of at least 20% for a conventional mortgage.
The deposit is paid when you make an Offer to Purchase to show that you are a serious buyer. The deposit will form part of your down payment with the remainder owing at time of closing. If for some reason you back out of the deal without having covered yourself with purchase conditions, such as financing, home inspection, etc., your deposit may not be refundable and you may be sued for damages. The size of the deposit varies.
Mortgage Loan Insurance Premium:
If you make less than a 20% down payment, you have a high-ratio mortgage. With a high-ratio mortgage your lender will need mortgage loan insurance. Mortgage loan insurance lets you buy a home with a minimum down payment of 5%.
Most Canadian lending institutions require mortgage loan insurance because it protects the lender. If the borrower defaults (fails to pay) on the mortgage, the lender is paid back by the insurer.. You pay a premium for mortgage loan insurance. Your lender will add the mortgage loan insurance premium to your monthly payments, or ask you to pay it in full upon closing.
Home Inspection Fee:
I almost always recommend making a home inspection a condition of your Offer to Purchase. A home inspection is done by a qualified home inspector to provide you with information on the condition of the home. Costs range depending on the age, size and complexity of the house and the condition that it is in. For example, it may be more costly to inspect a large, older, home, or one in relatively poor condition or that has many pre-existing problems or concerns.
- Legal fees
- Property insurance
- Moving costs
- Title insurance
- Water/septic tests
- Condo fees