How much house can you afford?

Congratulations on being pre approved for a mortgage! But how much should you actually spend on that new home?

Financial and real-estate experts agree that even with a pre approval in hand, it pays to be cautious when it comes to the purchase price.

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“Just because you’ve been approved for $350,000 doesn’t mean you actually have to spend that much,” says Vancouver realtor David Setton. “People are so overstretched financially these days.”

Given that a home is the biggest purchase people will make in their lives, the decision of how much to spend is an important one, especially for first-time buyers, says Credit Counselling Canada executive director Patricia White.

“Additional costs of taxes, utilities, and house insurance will add to the monthly expenses that might not have existed in a rental situation,” White says. “Add on maintenance and repairs and suddenly a house can be much more expensive.”

How to determine your monthly housing expenses

There are some basic rules when it comes to determining affordability.

The first is that your monthly housing costs shouldn’t be more than 32 percent of your gross monthly income. (This figure is called your gross debt service ratio.) Those costs consist of the monthly mortgage payments (principal and interest) as well as property taxes and heating, hydro, and water expenses. They also include condo maintenance fees.

The second is that your entire monthly debt load should not exceed 40 percent of your gross monthly income (called your total debt service ratio). That debt load includes the aforementioned housing costs as well as any other payments, such as car loans or leases, credit-card payments, and line-of-credit payments. 

Another cost home-buyers need to take into account is mortgage loan insurance, which helps protect lenders against mortgage default. This insurance enables people to buy homes with a minimum down payment of 5 percent.

The Canadian Mortgage and Housing Corporation has easy-to-use calculators to help determine household budget and mortgage affordability.

Once you’ve been pre approved, Toronto real-estate broker and accredited buyer’s agent Kimberley Marr recommends shopping around for a mortgage. “Mortgages are products, and it’s a very competitive marketplace out there,” says Marr, author of Your First Home—A Buyer’s Kit for Condos and Houses.


Choose the right mortgage for you

“Terms and conditions can vary. What you want is a complete package that meets your long- and short-term financial goals. A lot of buyers choose a mortgage based solely on lowest interest rate, but that may not suit your needs.”

In other words, don’t be too tempted by an extremely low interest rate and be sure to read all of the fine print, including penalties for breaking the mortgage.

Be especially careful when it comes to an adjustable-rate (or variable-rate) mortgage, in which the interest rate floats in conjunction with changes to the prime rate.

“While interest rates are lower, that’s great, but they’re not going to be low forever and ever,” Marr says. “Many people base their payments and purchase price on these lower rates. If rates go up and the mortgage payment goes up, that’s going to cause an increase in overall monthly payments. Can they carry that? Are they comfortable? I’m not saying don’t get an adjustable rate, but make sure you budget for if it goes up. You have to be able to sustain that. Understand the product.”

Upon pre approval, be sure the lender locks in the interest rate; this can be done for 60, 90, or 12 days. “Should rates go up, you’re protected if you purchase and close within that time frame,” Marr says.

It’s crucial to do a detailed budget before deciding on a mortgage amount.
“Don’t overextend yourself,” Marr says.  “Be prudent with your financial budgeting to have a buffer. You don’t want to become house-poor.”

There are other ways to do your mortgage right.

“Once you’ve been pre approved, don’t make any major financial changes in your life,” Marr notes. “Don’t get a new job. Don’t buy a new car or new appliances or whatever it is to up your debt load. The pre approval you’ve obtained is based on financial information provided to lenders, and any changes to that information could adversely affect the final approval.”

Budget, budget, budget

Make the largest down payment possible and have money set aside for the closing costs, which include legal fees and land transfer taxes.  “These costs are significant so ensure that you’re prepared,” White says. 

Also, consider potential income fluctuations, such as reduced income for maternity or paternity leave. “Basing a mortgage at the maximum of two incomes can become difficult if one income is reduced or removed,” White notes.

Avoid lines of credit that are offered by financial institutions for home renovations, furniture purchases, or unexpected expenses, White adds. It’s better to budget and save for such costs and to have an emergency fund for major repairs.

Borrowing less than the maximum amount for your house will ensure you’re not pushed to your upper limit, White says. “This will allow you to really enjoy home ownership.”