Mortgages: What can you afford?

Before you start looking for a home, you need to figure out what you can afford. This means closely examining your financial situation. Start by figuring out what you’re earning each month. Besides your salary, this figure could include bonuses, commissions, investment income, and rental income. Also make a list of your monthly expenses. These can include your rent, utilities, TV and internet service. If you take public transit, include your monthly fare. Or if you drive, include things like parking, gas, and insurance.

Expenses also include income tax and home insurance. Don’t forget to add your payments for any student loans or credit card debt payments. Use the form next to this video to help you make a complete list.

Calculating your net worth will help you determine how much you have for a downpayment. Add up all the amounts in your savings and chequing accounts, investments, TFSA’s and RRSP’s. If you own other property or cars, add that to your assets as well. Then list out your liabilities, which is what you owe. So things like car loans, credit card debt, student loans, and other lines of credit debt. Take all your assets, then minus your liabilities, and you’ll have your net worth. Use the form next to this video to work out your net worth.

There are two affordability rules or calculations that lenders will rely on when determining whether a potential borrower can actually afford the loan that they’re asking for. But you want to make sure that you don’t over-extend yourself financially, and that you’ll be able to support the mortgage payments on your monthly income.

Let’s go over each of these rules.

The first is called GDS Ratio or Gross Debt Service Ratio. Most lenders recommend that you spend no more than 32% of your gross monthly income on housing costs. Gross monthly income is your income before taxes. And housing costs, in the context of the GDS ratio, includes monthly mortgage principal, monthly mortgage interest, taxes, and heating costs, or PITH, for short.

If you’re buying a condo, you should add half of every month’s condominium or strata fees into your PITH total. For instance, if your gross monthly income is $4,000, multiply that by 32% and you’ll get $1,280. So your PITH should be no more than that amount.

The second affordability rule is the Total Debt Service Ratio or TDS. So what should your total debt-load be? According to most lenders, you should use no more than 40% of your gross monthly income to pay for your mortgages and cover the costs of all other debts, such as credit card bills, car payments, personal loans, alimony, and all other monthly expenses. If your TDS ratio exceeds 40%, you should consider reducing your outstanding debts before trying to take on a mortgage.

Financially, buying a home comes down to two key things: what you can afford to pay each month in mortgage payments and other debts, and secondly, how much you can afford as a downpayment. Now that you know how much you can afford to spend on your mortgage payments, check out the next video, which is all about downpayments and the other costs to home ownership that you’ll need to consider.