Home ownership – if it feels like a big step, that’s because it is. And with any big step you take in life there will be plenty of small steps you’ll need to take in order to reach your goal. It’s easy to get caught up in the excitement of buying a home, especially as you begin to take a look at what is available and think about the amenities and options that you would like to have. But before any of that, you need to ask yourself if you’re financially ready to buy. Though you may want to jump right to a resounding ‘yes’, it’s time to take a close look at your finances before you jump in with both feet.
Knowledge is Power
Having a household budget is essential – whether you’re a homeowner or not. But it becomes that much more important as you consider whether home ownership is right for you. Tracking your income and what you’re spending each month will help you determine if you can afford to buy a home, and how much home you can afford.
Your budget should not only include categories for income, but also your household expenses and monthly debts. Household expenses will include the typical categories of rent, heat, electricity, phone, internet, groceries; any everyday expenses that have you opening up your wallet. And yes, it should include that coffee indulgence on your way to work.
Monthly debts may include car loans and leases, personal loans or lines of credit, credit cards or student loans. List the amounts you pay each month under each category. It will also be beneficial to identify the term or timeframe of the loans or leases that you list.
There are many free, or almost free tools available to help you create a budget if you don’t already have one – CMHC Household Budget Calculator is one option, or the tried and true excel worksheet will also do the trick. Whatever tool you use, the important thing is that you have a realistic picture of your total monthly expenses which is calculated by adding your total household expenses with your monthly debt payments.
The Rules of Affordability
How much can you spend on a home? There are two affordability rules that will help you answer that question.
Rule 1 | Gross Debt Service Ratio
Have you heard of the Gross Debt Service or GDS ratio? The GDS ratio is the percentage of your gross monthly income that is allocated to your total housing costs. Your total housing costs include monthly mortgage payments, property taxes and heating expenses.
The first rule of affordability is that your monthly housing costs should not be more than 32% of your gross monthly income.
Rule 2 | Total Debt Service Ratio
Total Debt Service or TDS ratio looks at your entire monthly debt load, including your housing costs and all your other debt payments, such as car loans or leases, credit card payments and lines of credit payments.
The second rule of affordability is that your entire monthly debt load should not be more than 40% of your gross monthly income.
CMHC has a calculator on their website that will make determining your GDS and TDS ratios a snap.
Calculating the Maximum Price
The next step is calculating the maximum house price that you can afford. You can easily calculate this number by using our Mortgage Affordability Calculator.
Though you’ll want to confirm the numbers with your lender, it will give you a good idea of what you may be looking at in terms of a maximum house price and the monthly mortgage payment. The calculator also allows you to compare up to three different scenarios so that you can determine which mortgage product is right for you. After you’ve completed your calculations you can print, save and share your results.
A Word on Insurance & Down Payments
You’ll notice in our affordability calculator that mortgage insurance is referenced. Mortgage loan insurance helps protect lenders against mortgage default, and provides an opportunity for consumers to purchase homes with a minimum down payment starting at 5%. The minimum down payment required for mortgage insurance is dependent on the purchase price of the house.
For example; if the purchase price is $500,000 or less, the minimum down payment is 5%. When the purchase price is above $500,000, the minimum down payment is 5% for the first $500,000 and 10% for the remaining portion.
You’ll find a chart on the CMHC website here that outlines what you can expect in terms of the CMHC Mortgage Loan Insurance premium. You’ll notice the higher the percentage of the total house price/value that you borrow, the higher percentage you will pay in insurance premiums.
Now that you’ve examined your finances, is home ownership looking like a reality in the near future? If so, you’re ready to meet with a lender and get pre-approved for a mortgage.
If your financial picture is not making you feel confident about taking the leap into home ownership, don’t worry. There are likely some things that can be done to help put you on the path to owning your own home. Consider saving for a larger down payment, paying off some of your loans, or even looking at lower-priced homes. Your lender can also be a good resource and offer suggestions to help you get to where you want to be. The important thing to remember is not to get discouraged. With a little time, planning and expert advice to guide you, you’ll be well on your way to achieving your goal.
Do you have questions about buying a home? We would love to help. Get in touch with one of our Mobile Mortgage Specialists today.