You've found the home of your dreams, and now you want to find a mortgage in order to buy it. Our Beginner's Guide to Getting Your First Mortgage can help set you on the right track. But how much will you be able to borrow?
That depends on several factors, including your other debts, your income, and the amount you have available for a down payment. Banks and individual lenders have a formula they use when qualifying you for a mortgage, to determine how much they're willing to lend each individual or couple.
Here are several items that determine how much you can borrow.
The Lender's Calculation
Gross Debt Service (GDS)
This term refers to how much money you can afford to spend each month on home-related expenses such as mortgage, taxes, and insurance. To qualify for Canada Mortgage and Housing Corporation (CMHC) insurance, this can't be more than 32 percent of your combined monthly income. It's also the general rule of thumb for mortgage providers, although some will go higher.
Total Debt Service (TDS)
This is the total amount of debt you carry each month, including your home payment, and it shouldn't exceed 40 to 45 percent of your monthly income. To find out your total debt service, you'll need to include auto payments and any instalment payments you make each month.
You can calculate your GDS and TDS online to give you an idea of your percentages. Once you've calculated your monthly debt service, you can get a rough idea of how much you can afford to borrow with a mortgage affordability calculator.
Your credit score is another factor a lender will weigh when determining how much you can borrow for a new home. Each bank or mortgage provider has a formula that takes into account your debt ratio and credit score as part of the decision-making process. Credit cards that are charged to the limit and late payments on instalments are just a couple of the issues that can negatively affect your credit score. Having very little credit history is another reason for earning a lower score.
Credit scores range from 400 to 900, and a good credit score is anything over 600, while a score of 700 or higher is excellent. If your credit score isn't as high as you need it to be in order to obtain a mortgage, you can generally bring it up by modifying your spending behaviour. After a year of making payments on time and reducing credit card debt, you should see a significant rise in your rating.
Your Own Calculation
Despite the amount the bank approves, only you can accurately determine how much you can really afford. Taking a hard look at your expenses and spending habits will give a true picture of the price range you should be looking at when it comes to buying a new home. This handy monthly budget worksheet will give you an accurate look at your expenses so you can fit housing costs in comfortably.
Prepare a detailed list of monthly and yearly expenses to find out the level of your cash outflow. This should include household expenses like groceries, clothing, tuition, and child care. Make an honest assessment of how much you spend on entertainment including dining out, special events, hobbies, and travel. Don't forget to include expenses for gifts and charitable donations.
Be sure to also leave room in your budget for unexpected financial outlays. It's much better to buy a house that costs less than you're approved for by the lender than to buy a home you can't comfortably afford.
Other Costs to Consider
Most lenders require twenty percent down and charge higher interest rates for less than that. One of the benefits of having CMHC insurance is the ability to put as little as five percent down on your home mortgage. The cost of the mortgage insurance premium gets added to your loan up front and becomes part of the monthly payment.
In addition to your down payment, closing costs will include items like the home inspection and appraisal, legal fees, and taxes. The land transfer tax is by far the largest expense, although the bulk of it is waived for first-time home buyers. Typically, closing costs range between $2,000 and $4,000, depending on unique factors related to your home purchase.
The Typical Home Buyer
Using the mortgage calculator, a couple with a combined gross annual income of $110,000, monthly debt payments of $600, and anticipated monthly housing expenses of $2,520 gets a rough score of 27 percent GDS and 33 percent TDS. This is well within the guidelines for obtaining a mortgage.
The maximum monthly mortgage payment for this hypothetical couple would be around $2,000, and the maximum house price would be $400,000. This calculation includes a 4 percent interest rate with a five percent down payment, and it assumes a typical 5-year home loan amortized over 25 years. In fact, this couple could probably afford a larger mortgage although, as we pointed out, it's not always the best idea.
When you're looking to buy a home, the first thing you should do is closely examine your family's budget. This, together with the bank's determination, will help you decide the price range you need to target.
Understanding your own finances and the costs involved in purchasing a home will give you a clear picture of where to go next. We hope these tips will help with financing the home you deserve!