An important and sometimes challenging topic for those looking to buy is Mortgage Affordability: how much you can afford spending on your new home. In this article, we’ll go over some guidelines to help you have a better sense of what’s affordable for you.
When it comes to calculating mortgage affordability, there are four main categories lenders will look at:
How much you earn from different sources, such as your salary, child support, alimony, or income from investments.
Funds you have to go towards your down payment and closing costs, as well as other savings accounts and properties you may own.
Credit card, car, and student loan payments as well as your regular bills, like utilities and insurance fall under expenses.
Your credit score, payment history and outstanding debt are included in this category.
Generally, factors like your income, assets, and expenses are what will qualify you for financing, but your credit score and history will impact the actual interest rate you receive on a mortgage.
For lenders, determining mortgage affordability comes down to a few important percentages: 28%, 39% and 44%. These amounts are referred to as debt service ratios and help lenders understand how you’ll manage debt based on your income and other financial responsibilities.
|28%||or less of your gross monthly income should go towards your mortgage payment.|
|39%||or less of your gross monthly income should go towards housing costs. This percentage is called gross debt service (GDS) ratio and includes the mortgage principal and interest, taxes, heating, and condo fees if applicable.|
|44%||or less of your gross monthly income should go towards what’s called the total debt service (TDS) ratio. That includes everything covered in the gross debt service ratio plus any other monthly debt payments you have such as car loans, student loans, and credit card payments.|
These ratios are guidelines that most lenders will use when looking at whether a home is within mortgage affordability for prospective homeowners. Some lenders may be more or less lenient in what they deem affordable. For insured mortgages, also known as high-ratio mortgages, there is a firm limit on debt service ratios set by certain insurance providers. As of July 1st, 2020, Canada Mortgage and Housing Corporation (CMHC) set its limit for insured mortgages at 35% for GDS and 42% for TDS.
While GDS and TDS provide lenders with insight into what’s potentially affordable for homeowners, there are a few other factors you may want to consider to determine what’s truly within your mortgage affordability. Your lifestyle and future goals can impact what is realistically affordable in your situation. Perhaps you’re someone who values rest and relaxation, annual vacations may be a priority for you and are something you’ll probably want to save for. Or maybe you’re considering retiring early and putting funds aside for that goal is something you’re focused on. When you’re assessing your income, assets, and expenses, allow for some buffer room so you’re still able to afford things that matter to you. It’s all about finding balance!
Now that you know what goes into determining how much house you can afford, here are a few ways to increase that amount and improve your mortgage affordability – your buying potential!
Increase your down payment: Any extra funds you can put towards a down payment are useful, especially if it allows you to put down at least 20% of the purchase price of the home you’re looking at buying.
Pay off debts: Paying off outstanding credit card debt or loans is a good indicator to lenders that you’re a responsible borrower and will mean less money going towards debt repayment when you do purchase your home.
Increase income: There are various ways to increase your income like asking for a raise at your current job, finding a more well-paying position, or even taking on a second job to supplement your income. By boosting your earning potential, you’ll have more income that could go towards paying down a mortgage.
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Source: MCAP Blog