How Much Can You Afford?
November 9, 2012 | Posted by: Laurie Anne Faulkner
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
Your monthly housing costs shouldn't be more than 32% to 34% (with a maximum of 39%) 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. If you are buying a condominium or leasehold tenure monthly condominium fees.
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 must no more that 39% of your gross household monthly income.
Affordability Rule #2
Additionally, your entire monthly debt load should not be more than between 42% and 44% 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). This figure is called your Total Debt Service (TDS) ratio.
Your Maximum House Price
The maximum home price that you can realistically afford depends on a number of factors. The most important factors are your household gross monthly income, your down payment and the mortgage interest rate. For many people, the hardest part of buying a home — especially their first one — is saving the necessary down payment.
Note: For CMHC-insured mortgage loans, the maximum purchase price or as-improved property value must be below $1,000,000.00 when the loan-to-value ratio is greater than 80%.
Mortgage Loan Insurance
Mortgage loan insurance helps protect lenders against mortgage default, and enables consumers to purchase homes with a minimum down payment of 5% — with interest rates comparable to those with a 20% down payment.
The CMHC Mortgage Loan Insurance premium is calculated as a percentage of the loan and is based on the size of your down payment. The higher the percentage of the total house price/value that you borrow, the higher percentage you will pay in insurance premiums. The cost for Mortgage Loan Insurance premiums is usually offset by the savings you get from lower interest rates.
Note: The amortization cannot exceed 25 years for mortgage loan-to-value ratios > 80%.
Do Your Calculations Look Encouraging? What is your current financial situation?
You may need to step back and re-evaluate your house goals and dreams. Consider the following which may improve your housing outlook for the long run and help you afford the home you would like:
- Pay off some loans first.
- Save for a larger down payment.
- Take another look at your current household budget to see where you can spend less. The money you save can go towards a larger down payment.
- Lower your home price — remember that your first home is not necessarily your dream home.
Before approving a mortgage, lenders will want to see how well you have paid your debts and bills in the past. To do this, they consider your credit history (credit report) from a credit bureau and review your beacon score. This tells them about your financial past and how you have used credit.
You can get a copy of your own credit history any time you like and should do so at least once a year to check for any inaccuracies. There are two main credit-reporting agencies: Equifax Canada Inc. and TransUnion of Canada. You can contact either one of them to get a copy of your credit report for free by mail or a samll fee for having it emailed immediately.
Once you receive your credit report, examine it to make sure the information is complete and accurate.
If You Have No Credit History
If you have no credit history, it is important to start building one by, for example, applying for a standard credit card with good interest rates and terms, making small purchases and paying them as soon as the bill comes in.
If you have poor credit, lenders might not be able to give you a mortgage loan. You will need to re-establish a good credit history by making debt payments regularly and on time. Most unfavourable credit information (including bankruptcy) drops off your credit file after seven years.
Call me and I can help you determine what you can afford today or help you plan for tommorw.
Laurie Anne Faulkner 250-588-2288