How Much Can I Afford?
Buying a home is a very emotional
experience. Similar to when shopping
for a car, people often get caught
up in the moment and end up with
more than they can afford. The difference
is that a home generally costs a
lot more than a car and is an even
longer term investment, so knowing
what you can comfortably afford
is one of the key first steps in
the process.
Also, with interest rates at nearly
an all-time low and competition
among lenders at an all-time high,
it can be very easy to get approval
for a mortgage that is more than
you can afford.
Qualifying: How much is "normal"?
A good rule of thumb is that most
people will qualify for a mortgage equal to about three times their
gross annual income. This will give
you a very rough idea of what you
will qualify for, not necessarily
what you can afford. You need to
look at your cash flow and determine
what makes sense for you. More on
that later on.
So, assuming the three times of
gross annual income ratio, this
means that if you and your spouse
each earn a $50,000 gross salary
each year, you can, on average,
expect to qualify for a mortgage of around $300,000.
Keep in mind, though, that lenders
are very particular when it comes
to defining gross income. If you
work lots of overtime or work in
a job where commissions (or even
tips) make up a large proportion
of your income, you will need to
prove that this portion of your
income is sustainable. Being able
to demonstrate that you have received
a certain amount consistently in
commissions for the past 2-3 years,
for example, will help ensure that
this variable income is factored
into your mortgage qualification.
Qualifying when you're a commission
earner and/or self-employed
If you are self-employed, the lender
will look at your net taxable income
over the past 2-3 years as it shows
on your Canada Customs & Revenue
Agency ("CCRA" - formerly
Revenue Canada) Notice of Assessments.
These figures are then usually averaged
to give an estimate of future income
expected.
Unfortunately, most self-employed
individuals will find that all the
work they did to keep their net
taxable income low can have a negative
impact on their qualifying for a
mortgage. Why is this? Simply put,
lenders don't like taking risks
and they don't like the idea
of lending to someone whose future
income is uncertain. Worse, not
only will they look at your income
averaged over a time period, but
they will often take it one step
further by looking at your net income
after you have deducted all your
expenses for tax purposes.
In other words, a commissioned or
self-employed person with $50,000
in gross income would (in most cases)
fail to qualify for the same mortgage amount as a salaried employee who
makes $50,000 per year, since the
commissioned or self-employed individual
can write off office expenses, car
expenses, cell phones, entertainment,
etc.
This means that lots of people who
truly can afford a large mortgage have trouble qualifying for that
mortgage because they declare very
little income for tax purposes.
The good news
Recently, a few lenders have acknowledged
the fact that commissioned earners
and the self-employed are actually
generally pretty reliable when it
comes to repaying their mortgages.
New programs cater specifically
at these people to allow them to
buy a home without showing any,
or very little, income. The caveat:
these programs usually require a
downpayment of at least 15% of the
purchase price or more.
Qualifying: More calculations for
the mathematically inclined...
Want to take this one step further?
Simply calculate the same two ratios
typically used by a lender to qualify
you for a mortgage, as follows:
Gross Debt Service Ratio (GDSR): Simply add together your monthly
mortgage payment plus 1/12th of
annual property taxes plus $75 for
monthly heating costs. Divide this
sum by your gross monthly income
to get your GDSR. Expressed as a
percentage, a GDSR is less than
32% is desirable.
Total Debt Service Ratio (TDSR): Similar to the GDSR. Add together
your monthly mortgage payment plus
1/12th of annual property taxes
plus $75 for monthly heating costs
plus any other monthly payments
(
loans, lines of credits, car leases,
minimum payments on credit cards,
etc.) Divide this sum by your gross
monthly income to get your TDSR.
Expressed as a percentage, a TDSR
of less than 40% is desirable.
Now, what can I actually afford?
Even though you may be able to qualify
for a specific amount for a mortgage,
it doesn't mean that you should
apply for that amount. After all,
a lot of what you can afford (as
opposed to qualify for) is about
your lifestyle. For example, if
you like to eat out a lot, your
ability to afford a certain level
of mortgage will be different than
someone who eats at home all the
time and packs a lunch each day.
So, what's the best way to approach
this? It's simple: work backwards.
Decide just how much you really,
truly can afford to pay each month
for your "shelter costs" and then work backwards to figure
out how much of a mortgage you need.
Remember, shelter costs includes
your mortgage payment, property
taxes, heat, hydro, water, etc.
The bottom line
Be generous when calculating your
costs, and be conservative when
calculating your income. It is far
better to have a smaller mortgage that you can comfortably afford
than to be trapped into a larger
mortgage that has you stretching
every last dollar. After all, there
is no fun in getting that dream
home but then being unable to afford
to furnish it or being unable to
leave that house for the occasional
night out!
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