Mortgage Affordability

When shopping for a new home, the first step is to figure out how much you can afford.  Affordability is based on the household income of the applicant(s) purchasing the house, the personal monthly expenses of those applicants (car payments, credit expenses, etc.), and the expenses associated with owning a home (property taxes, condo fees, and heating costs).

You also need to determine if you have enough cash resources to purchase a home.  The cash required is derived from the down payment put towards the purchase price, as well as the closing costs that must be incurred to complete the purchase.

How to Estimate Affordability

Lenders look at two ratios when determining the mortgage amount you qualify for, which generally indicate how much you can afford. These ratios are called the Gross Debt Service (GDS) ratio and Total Debt Service (TDS) ratio. They take into account your income, monthly housing costs and overall debt load.

The first affordability rule, as set out by the Canada Mortgage and Housing Corporation (CMHC), is that your monthly housing costs – mortgage principal and interest, taxes and heating expenses (P.I.T.H.) – should not exceed 32% of your gross household monthly income. For condominiums, P.I.T.H. also includes half of your monthly condominium fees. The sum of these housing costs as a percentage of your gross monthly income is your GDS ratio.

The CMHC’s second affordability rule is that your total monthly debt load, including housing costs, should not be more than 40% of your gross monthly income. In addition to housing costs, your total monthly debt load would include credit card interest, car payments, and other loan expenses. The sum of your total monthly debt load as a percentage of your gross household income is your TDS ratio.

Down Payment

Because the minimum down payment in Canada is 5%, this benchmark is used to determine your maximum affordability. Ignoring income and debt levels, your maximum mortgage would be [down payment $ ÷ 5%]. Any mortgage with less than a 20% down payment is known as a high-ratio mortgage, and requires you to purchase mortgage default insurance, commonly referred to as CMHC insurance.

Cash requirement

In addition to your down payment and CMHC insurance, you should set aside 1.5% – 4% of your home’s selling price to cover closing costs, which are payable on closing day. Many home buyers forget to account for closing costs in their cash requirement.