Designing a Mortgage That's Right For You!
Before shopping for a new home, your first step should be figuring out how much house you can afford. Home affordability is calculated on the total household income, the personal monthly expenses of that household (i.e. car loan payments, credit accounts, etc.), and the projected expenses of the new home (i.e. property taxes, condominium maintenance fees, and utility costs). You also need to consider whether you have enough liquid cash to purchase a home. You'll need cash to pay the down payment and closing costs of the home.
Home lenders look at two factors when determining how much mortgage you qualify for: the Gross Debt Service (GDS) ratio and the Total Debt Service (TDS) ratio. These two ratios indicate how much you can afford. Lenders also consider your monthly income, monthly living costs, and how much debt you're carrying.
The first affordability rule, according to the Canada Mortgage and Housing corporation (CHMC) is that your monthly housing costs do not exceed 32 percent of your gross household monthly income. Your monthly housing costs include your mortgage principle and interest, taxes, and heating costs (P.I.T.H.). Your GDS ratio is the sum of these housing costs expressed as a percentage of your gross monthly income. For condominiums, P.I.T.H. also includes half of your monthly condominium maintenance fees.
The CHMC's second affordability rule is that your total monthly debts, including housing costs, should not exceed 40 percent of your gross monthly income. Your total monthly debt load includes housing costs as well as car loan payments, credit card interest, and other loan fees. Your TDS ratio is the sum total of your monthly debt load expressed as a percentage of your gross household income.
Since the minimum down payment in Canada is 5 percent, this is the benchmark used to determine whether you can afford a house at a certain price. A mortgage with less than a 20 percent down payment is called a high-ratio mortgage, and will require mortgage default insurance (also called CHMC Insurance). Your mortgage default insurance cost can be calculated by subtracting your down payment from the purchase price and dividing the sum by 5 percent of that number.
For example, suppose you wanted to purchase a $100,000 home with a down payment of $5000. Your mortgage is $95,000. Divide the $95,000 mortgage by five percent ($1,500) and you'll have your monthly mortgage default insurance cost, $63.
Cash on Hand
Don't forget to account for closing costs. In addition to your down payment and mortgage insurance, you should have 1.5-4 percent of your home's purchase price available in liquid cash to cover closing costs.