Nobody wants to get in over their head when buying a home and that’s why it’s a good idea to calculate how much you can afford before committing to anything. How much you can afford will basically depend on the combined annual income of the prospective owners and the cost of their monthly bills such as insurance, car payments and credit card and/or line of credit debt, etc. However, you also need to consider the costs that will come with buying the home such as heat, hydro, water, property taxes, and condo fees (if your purchase includes this as a monthly cost).
In addition, homebuyers in Ontario will need a minimum amount of cash available for a down payment and closing costs. Because of these monthly bill payments, a new homeowner should be looking for the best mortgage deal possible when it comes to interest rates, the length of term, and the mortgage product as a whole. Mortgage lenders want to be assured that you have enough money left over to make their payments after the rest of your costs are taken care of. Lenders will take the facts and figures of your income and monthly expenses and determine how much they’re willing to lend you, based on both their own underwriting rules as well as those of the Government of Canada.
GDS and TDS Ratios
There are two important ratios to a lender which are known as the GDS (Gross Debt Service) and the TDS (Total Debt Service). These take your total income and overall debt responsibilities into account. Also, there are certain CMHC (Canada Mortgage and Housing Corporation) affordability rules which need to be followed. According to the CMHC, a homebuyer’s monthly housing bills shouldn’t add up to over 32 percent of the gross monthly income for the household. There are exceptions to this rule as some lenders are willing to go up to 39 percent, but only if you have a credit rating of over 680. These housing costs are known as P.I.T.H. and consist of the principal and interest of the mortgage as well as the taxes and heating expenses. If you plan on buying a condominium, the monthly condo fees are also added to the P.I.T.H. figure. The percentage of the housing costs to the gross monthly income makes up the GDS ratio.
The TDS ratio encompasses everything outlined above in the GDS, plus any other monthly expenses such as car payments, credit card payments, line of credit payments, etc. Essentially, any other monthly debt payment is added to come up with your TDS ratio, which typically needs to be below 40 percent, however with a credit rating above 680, most lenders will lend to 44 percent TDS, as they see the borrower as being able to manage a slightly larger credit load because of their stellar credit history.
Monthly Debt vs Monthly Income
Another affordability rule states that your total amount of monthly debt shouldn’t exceed 40 percent of the gross monthly income. This debt servicing ratio includes your housing costs (GDS) as well as other debts such as car, line of credit, and credit card payments, etc. The total of the monthly debt compared to the gross income of the household represents the percentage of the TDS, or Total Debt Service Ratio. Essentially, any other monthly debt payment you have is added to come up with your TDS ratio. With a credit rating above 680, most lenders will lend to 44 percent TDS, as they see the borrower as being able to manage a slightly larger credit load because of their stellar credit history.
The purchase price of the property, as well as the amount of your down payment, also comes into play when determining affordability if you are putting less than 20 percent down, as you must then get mortgage default insurance through CMHC, Canada Guaranty, or Genworth. This is what is referred to as a high-ratio mortgage. When the insurers are involved, they have their own rules when it comes to lending on mortgages for home purchases with less than 20 percent down. Depending on the purchase price of the home, there are rules that determine the minimum down payment necessary in order to do so. See below for examples of the maximum purchase price when purchasing a home with the minimum down payment allowed:
If the down payment is $25,000 or under you can help determine the maximum purchasing price by applying the formula of:
Down payment / five percent = maximum affordability.
If the down payment is over $25,000, the maximum purchase price can be determined by this formula: the amount of the down payment amount minus $25,000 / 10 percent + $500,000. For instance, if your down payment is $40,000 you would minus $25,000 for a total of $15,000. Multiply this amount by 10 to equal $150,000 and then add $500,000 for a grand total of $650,000.
In addition to paying the down payment, it’s essential that you put aside at least 1.5 percent of the purchase price of the home to take care of the closing costs, which is required by all lenders in order to close on the property. These closing costs include land transfer tax and legal fees.
Get Help Before You Apply For a Mortgage
Even with the aid of calculators and formulas, it can still be confusing when trying to determine how much you can afford for a home. This is why you can always turn to MortgageMeister.com for assistance from our experienced, professional team. We’ll be glad to answer any questions you may have regarding all types of residential and commercial mortgages.