Are You Financially Ready?
So, you’ve decided that homeownership is right for you. Now you need to determine if you are financially ready to buy a house. In this Step, you will find a number of simple calculations that you can do to evaluate your current financial situation, how much house you can afford and the maximum home price that you should be considering.
To avoid any future surprises, you can do some financial exercises to see where you stand. They include calculating your net worth, determining your current monthly expenses and what your current monthly debt payments are.
Knowing your net worth is important because you will need this information when you discuss a mortgage with your mortgage professional. Your net worth is the amount left over once you’ve subtracted your total liabilities from your total assets. It will also give you a snapshot of your current financial situation and show you how much you can afford to put as a down payment.
How Much Can You Afford?
Now that you have a clear picture of your current financial situation, it’s time to find out what you can afford in monthly housing costs. Lenders follow two simple affordability rules to determine how much you can pay.
The first affordability rule is that your monthly housing costs shouldn’t be more than 32% of your gross household monthly income. Housing costs include monthly mortgage principal and interest, taxes and heating expenses — known as P.I.T.H. for short. For a condominium, P.I.T.H. also includes half of the monthly condominium fees. For leasehold tenure, P.I.T.H. includes the entire annual site lease.
Lenders add up these housing costs to determine what percentage they are of your gross monthly income. This figure is known as your Gross Debt Service (GDS) ratio. Remember, it must be 32% or less of your gross household monthly income.
The second affordability rule is that your entire monthly debt load shouldn’t be more than 40% of your gross monthly income. This includes housing costs and other debts, such as car loans and credit card payments. Lenders add up these debts to determine what percentage they are of your gross household monthly income. This figure is your Total Debt Service (TDS) ratio.
Your Maximum Home Price
The maximum home price that you can afford depends on a number of factors but the most important are your gross household income, your down payment and the mortgage interest rate.
This table gives you an idea of the maximum home price you can afford.
Income, Home Price and Down Payment Guide
|Household Income||5% Down Payment||Maximum Home Price||10% Down Payment||Maximum Home Price||25% Down Payment||Maximum Home Price|
|Figures are rounded to the nearest $100.|
The Income, Home Price and Down Payment Guide table assumes a mortgage interest rate of 8%; average tax and heating costs in Canada; and the mortgage an average Canadian would qualify for based on a 32% debt/service ratio.
For most people the hardest part of buying a home – especially the first one – is saving the necessary down payment. Many people will not have 20% of the purchase price to put down. With mortgage loan insurance, you can purchase a home with as little as 5% down payment. Mortgage loan insurance protects the lender and, by law, most Canadian lending institutions require it. The way it works is if the borrower defaults (fails to pay) on the mortgage, the lender is paid back by the insurer. The cost for this type of insurance is in the form of a premium and can be paid in a single lump sum or it can be added to your mortgage and included in your monthly payments.
Most mortgage loan insurance products require homebuyers to provide the down payment from their own resources, such as savings and RRSPs. Gift down payments from immediate relatives are also acceptable.
For down payments of less then 10%, CMHC enables lenders to offer homebuyers the flexibility to use additional sources of down payment such as borrowed funds or lender incentives.
|Financing Required||Premium % of Loan Amount|
|Up to and including 65||0.50|
|Up to and including 75%||0.65|
|Up to and including 80%||1.00|
|Up to and including 85%||1.75|
|Up to and including 90%||2.00|
|Up to and including 95% Traditional Down Payment Non-traditional Down Payment||2.75 2.90|
|Extended Amortization SurchargesGreater than 25 years, up to and including 30 yearsGreater than 30 years, up to and including 35 years||0.20 0.40|
|*Premiums in Ontario and Quebec are subject to provincial sales tax. The provincial sales tax cannot be added to the loan amount.|
Get a Mortgage Pre-Approval
Once you’ve made the necessary calculations and feel that you are ready to obtain a mortgage, it’s a good idea to select a lender to get pre-approved. This means that the lender will look at your finances to establish the amount of mortgage you can afford. At that time, the lender will give you a written confirmation or certificate for a fixed interest rate good for a specific period of time.
Some buyers may not wish to pursue a mortgage pre-approval until they have found the home they want to buy. However, having a pre-approved mortgage amount makes the search for your new home much easier and less time-consuming because you have a good price range in mind.
Some of the things you will need to have with you the first time you meet with a lender are:
- Your personal information, including identification such as your driver’s license
- Details on your job, including confirmation of salary in the form of a letter from your employer
- Your sources of income
- Information and details on all bank accounts, loans and other debts
- Proof of financial assets
- Source and amount of down payment and deposit
- Proof of source of funds for the closing costs (these are usually between 1.5 of the purchase price)
Will You Have Trouble Qualifying for a Mortgage?
Your calculations may show that you will have trouble meeting monthly debt payment and that you will likely have trouble getting approved for a mortgage. Here are some things you can do:
- Pay off some loans first
- Save for a larger down payment
- Revise your target house price
Other Helpful Strategies
- Meet with a credit counsellor who can help you minimize your debts.
- Buy your home through a rent-to-own program provided by the builder, a non-profit sponsor or a government sponsor.
- Find out about programs through which you can help build your own home.
- Ask the housing department of your municipality about any special programs available.
The Importance of Your Credit Rating
Before approving you for a mortgage, lenders will want to see how well you have paid your debts and bills in the past. To do this, they simply get a copy of your credit history (credit report) from a credit bureau. This provides them with information on your financial past and use of credit. Before your lender sees your credit history, you should get a copy for yourself to make sure the information is complete and accurate. Simply contact one of the two main credit-reporting agencies (Equifax Canada Inc. or TransUnion of Canada) to get a copy of your credit report. There is often a fee for this service.
Lack of 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.
Fixing a Credit Record
If you have bad credit, lenders might not want to give you a mortgage loan until you can re-establish a good credit history by making debt payments regularly and on time. Most unfavourable credit information, including bankruptcy, is dropped from your credit file after seven years. If you have bad credit, you may want to consider credit counselling.
Despite your poor credit history, you might still be able to get a mortgage loan if you have a relative such as a family member willing to be a guarantor or co-signer on the loan. This person must meet the lender’s borrowing criteria, including good credit history, and is legally obligated to make the mortgage payments if you do not.