Mortgage loans are a popular way for people to buy their own homes and begin the process of homeownership. With this type of loan, a borrower can borrow money from the bank to pay for the purchase of his property. In most cases, mortgage holders will use part or all of their net equity (the difference between your house’s market value and current debt) as paid-in-full funds for the loan.
It is not easy determining how much mortgage you can afford based on Canada’s current housing prices because interest rates vary depending on location. In order to obtain an accurate understanding of your mortgage potential, it’s essential to consider the average Canadian home price and the interest rate that you would need to pay to reach your desired purchase price.
This article will give you a good idea of what kind of mortgage you can afford with details of all the necessary costs that should be considered.
What Canada Mortgage Amount Can I Afford?
The amount of mortgage you can afford varies based on several factors, including salary and your total debt load, but it’s important to note that lenders or other institutions can’t determine your maximum monthly income. Furthermore, what may seem like an affordable amount may place a lot of financial stress on you if other costs outside of the home also need to be considered.
The following steps will help you determine how much mortgage you can afford;
Understanding the Market Value of Your Home
Before choosing your down payment amount, you should calculate the market value of your home. Your home’s market value can vary depending on factors such as the property’s age and location. Some areas are more attractive than others, which can also affect the price of a home significantly.
So if you do not agree with a lender’s initial estimate of your mortgage capacity, it is important that you speak with them directly and explain why they may or may not be generous in their offer.
The amount by which a homeowner can make his down payment is governed by the following factors:
Property location (some areas are more attractive than others, which can affect the price of a home significantly)
Property’s age (will decrease the value of your home)
Size (large homes are more expensive to heat and maintain than smaller ones)
Condition (the value of a house will decrease if it needs repairs or remodeling)
Occupancy status (a house that is unoccupied also decreases in value; since empty houses require less maintenance and can attract robbery).
Assessing Your Debt Load
This is a common mistake for many potential home buyers who are looking to buy a home and do not have a clear understanding of what they owe on their mortgage or other loans.
The amount by which you can afford your down payment will depend on the total amount of your outstanding debt load. The idea behind this is that if you put less money down towards your down payment, then that means you have more money left over, which could go towards paying off your other debts.
For example, suppose you are paying $1500 per month on all the debts that you have accumulated over the previous year (including principal and interest). In that case, it will take only 20% ($300) from what is left over after making your mortgage payments so that you can put down $30000.
Therefore, the assumption is that you will be able to make a 20% down payment on your house and be able to pay off all your existing debts plus the new mortgage.
Determine if the Mortgage is Affordable
There are numerous ways to calculate how much mortgage you can afford in Canada, but the easiest way would be using the type of calculator available on CMHC’s website, which includes several variables that would allow you to test different scenarios at once.
For example, you can enter your annual income, debt load, type of house, and the amount of mortgage you want to pay each month and see if it falls under your budget. Alternatively, you can use the methods below to gauge your mortgage affordability as experts have approved them.
The 4.5X your income rule:
4.5X your income rule is a good starting point to determine if you can afford a house, as it places greater emphasis on actual affordability than on you allocating a larger portion of your salary to housing.
This rule states that your household income should be at least 4.5 times larger than your annual expenses and includes things such as mortgage, taxes, property insurance, and utilities.
For example, if you make $70,000 per year, then you would like to make sure that your total household expenses and mortgage would be less than $315,000, which is equal to 4.5 times greater than your income.
Gross debt service ratio:
Another rule to follow when estimating your maximum monthly income and figuring out how much mortgage you can afford is the gross debt service ratio. This ratio states that your gross debt service should be less than 32% of your total gross income.
For example, if you make $70,000 per year and want to purchase a house for $250,000 in Canada, then you would need to make sure that your gross debt service ratio is less than 32% or 32% of $70,000, which equals around $2400 per month or $27,600 per year.
Total Debt Service Ratio:
Many debt service ratios are used as part of the Canadian Mortgage and Housing Corporation’s (CMHC) Basic Mortgage Ratios to identify borrowers who may not have sufficient financial strength to purchase a home or who are at high risk of defaulting on their mortgage.
Most lenders use your total debt service ratio to determine how much mortgage you can afford. This is similar to your GDS ratio, except it includes any additional debt you may have, such as:
Lenders typically impose a 40% limit on your TDS ratio because the higher this number is, the greater risk you may be incurred if a financial emergency occurs.
How your down payment affects your housing affordability
Your ability to make a down payment on a home determines how affordable it should be for you. This means that if you were to purchase a $300,000 home, it would need to have a $2400/month repayment capacity.
Some lenders will require you to make a down payment of at least 20% of the purchase price, which is not enough to qualify for an all-inclusive mortgage amount that they give out in Canada because it is based on the property’s value. A lower down payment of less than 20% will result in a higher monthly mortgage payment.
How good credit affects your housing affordability
Your history of managing credit and paying bills on time should be a key factor when calculating how much money you can afford each month. If you have had a poor credit rating in the past, then you may have already damaged your ability to qualify for an all-inclusive mortgage amount from your lender.
On the other hand, if you have a good record of managing credit, then it will make it easier for you to get approved for a home loan with better terms and conditions.
Additional expenses to take into account for mortgage affordability
Closing costs: One of the main factors that you will need to consider is the closing costs associated with buying a house in Canada. There are additional fees you will need to pay at the time of closing, including registration, appraisal, title search, and land transfer tax.
For example, if your home purchase is $250,000, then you could expect to pay around $5,000 in closing costs which can also affect your maximum monthly income.
Moving Cost: Moving is also a cost that you will need to consider when determining how much mortgage you can afford. This includes things such as truck rental, storage, insurance, and fuel.
You may want to check with friends or relatives before moving to get an estimate on how much it will cost for you to move your belongings from one place to the next.
Life changes: You should also consider the chance that life changes can happen in the future, which could affect your income and ability to save each month towards purchasing a home.
When you buy a home five years from now, your current income must still support this expense since many people’s incomes change based on promotions, raises, or other employment opportunities.
Savings: You should also consider the amount that you have saved for your down payment toward purchasing a house in Canada (if applicable).
This will affect how much mortgage you can afford because if you have saved up less than 30% down, it becomes harder to qualify for a mortgage and get good interest rates on a home loan in Canada.
Finding the right home and finding the right mortgage can be hard sometimes, especially if you don’t know where to start. The tips above should help you determine how much housing costs in Canada you can afford as well as how much down payment you will need.
When looking at purchasing a house, it is important to factor in your life changes, income, debt load, and maximum monthly expenses so that you can purchase a home within your budget.
Sagar Sridhar is a personal finance blogger from Canada. His genuine passion for personal finance coupled with his unique style of writing is what stands out. Professionally, he is a computer engineer, agile certified and has a master’s degree in Project Management. His writing has been featured or quoted in the leading Canadian publications such as Credit Canada and many other personal finance publications. While he is juggling between his day job and blogging, he is the main author on this blog and has miles to go before making the final pit stop.