Chapter 2- How much can you afford?

A critical first step on your home buying journey is to determine what you can afford and create a budget. This will help you manage your financial obligations and responsibilities while avoiding overborrowing. Taking the time to create a budget and gain greater insight into your financial health will also help you be more prepared when you eventually sit down with you your mortgage broker or financial planner.

 

Create a budget and determine what you can afford to spend on a home in four easy steps.

 

First, determine and understand what you are currently spending.

• Gather a list of all your sources of income and a list of all your expenses. Create a line by line budget including every expense you can think of. Then determine what your net surplus or deficit is by subtracting your monthly expenses from your income.
• Not sure where to start? Refer to our Appendix for a sample budget and other helpful resources. You can also use our online tools at www.NestandCastle.com/EducationCentre.

 

Second, determine how much you can afford.

• Using some of the information you collected from Step 1, you will now determine how much you can afford to spend based on the two guiding rules of home financing: your Gross Debt Service (GDS) Ratio and your Total Debt Service (TDS) Ratio.
• Lenders use GDS and TDS to determine how much debt you can handle when applying for a mortgage. These ratios, as well as other key factors such as your credit score, will determine the amount of financing you qualify for and thus the amount you can afford to spend on a home.

 

Affordability Rule 1: Gross Debt Service (GDS) Ratio

GDS considers your monthly household expenses relative to your gross monthly income. Household expenses include mortgage/rent payments, property taxes, heating costs, and 50% of applicable condominium fees (if applicable). Your GDS should be below 32%.

 

To calculate your GDS, take your total monthly household expenses (mortgage/rent payments, property taxes, heating costs, and 50% of condominium fees – if applicable) and divide by your gross monthly income. Then multiply the result by 100 to get a percentage. 

 

Gross Debt Service (GDS) Ratio Calculation
	Sample calculation	Your current GDS calculation	Your future GDS calculation
Total mortgage/rent payments (monthly)	$1,500
Property taxes (monthly)	$150
Heating costs (monthly)	$100
50% of condo fees (monthly)	$250
Total Monthly Household Expenses	$2,000
Gross Monthly Income	$8,000
Divide Total Monthly Household Expenses by Gross Monthly Income, then multiply by 100	($2,000/$8,000) x 100 = 0.25 x 100
GDS	25%

 

Affordability Rule 2: Total Debt Service (TDS) Ratio

TDS considers how much of a mortgage you can afford given your existing debt. TDS considers whether having a new mortgage will impact your ability to service (pay) your existing debt. Your TDS ratio should be below 40%.

 

Total Debt Service (TDS) Ratio Calculation
	Sample Calculation	Your current TDS calculation	Your future TDS calculation
Total Monthly Household Expenses (amount calculated from Rule 1)	$2,000
Car loans or leases	$500
Credit card payments	$100
Line of credit payments	$200
Other mortgage payments or other loan payments	$0
Total Expenses	$2,800
Gross Monthly Income	$8,000
Divide Total Expenses by Gross Monthly Income, then multiply by 100	=($2,800/$8,000) x 100 = 0.35 x 100
TDS	35%

 

If your GDS and TDS ratios are below 32% and 40% respectively and you have a good amount saved for a down payment, you most likely won’t have an issue qualifying for a mortgage.

 

Third, determine your upfront costs.

Now that you have determined how much you can afford, take the time to determine how much you will need to save for the upfront costs associated with buying a home. Consider some of the following:

1. 1. Down payment – depending on the purchase price of your home, you will need to save at least 5-20% of the purchase price of the home as a down payment.

• Home inspection and appraisal fees

• Insurance costs – including property insurance, mortgage default insurance, etc.

• Land registration fees – percentage-based variable fees based on the purchase price of the property

• Prepaid property taxes and utility fees – you may have to reimburse the seller for prepaid property taxes and/or utility fees. This will be taken care of by your lawyer on closing with your statement of adjustments.

• Legal or notary fees

• Potential repairs or renovations

• Moving costs

• Taxes (GST/HST/QST) – if the property is newly built, you may have to pay taxes to the government (GST/HST/QST). You may also need to pay tax on the insurance premiums for loan default insurance, if applicable.

 

Please note that this list is not exhaustive. You may need to budget additional funds for other upfront costs.

 

Fourth, determine what your new monthly budget will look like as a new homeowner.

Now that you have an idea of what your current budget looks like and what you can afford, take the time to create a new budget considering the increased costs associated with homeownership. Be sure to include every expense you can think of – it’s always best to include too much than too little. 

 

If your monthly housing costs (GDS) and debt load (TDS) are over 32% and 40% respectively, you may have problems qualifying for a mortgage. Consider re-evaluating your budgets.

 

Simplify your affordability and budget calculations by using our online tools 

Our online home affordability calculator is a great free tool at your fingertips that you can use to help simplify the calculations for you and to gain a greater understanding of what you can afford. Visit www.NestandCastle.com/EducationCentre to take advantage of this great tool.

 

Curious to see what your mortgage payments will look like?

Our online mortgage payment calculator is a great way to estimate what your mortgage payments will be under different terms, such as variable or fixed interest rates. Explore more at www.NestandCastle.com/EducationCentre.

 

Next steps

It is important to keep in mind that how much you can borrow and how much you can afford may not necessarily be the same. You may be able to borrow $500,000, but you need to ensure that you can keep up with the repayment terms of your mortgage down the road. 

 

Taking the time to create a budget and to understand your financial picture will not only help you narrow down your property search results by what you can afford, but it will also better prepare you for the financial responsibility of homeownership.

 

If you can afford the home you want, that’s great! However, if you think you’ll have trouble making mortgage payments, or you’re concerned about your finances, you can still make changes. Here are some tips to help you afford the home of your dreams:

• Meet with a financial planner to create a comprehensive financial plan that includes improving your credit score.

• Look at your current budget to determine where you can spend less and save more.

• Pay off some debt.

• Save for a few more years for a larger down payment.

• Lower your price range for a home.

 

Government of Canada Programs to Support Homebuyers

The Government of Canada offers a few programs to home buyers that you may be eligible to take advantage of depending on your unique situation and the type of property you are purchasing. 

 

• First-Time Home Buyers’ (FTHB) Tax Credit

The FTHB Tax Credit offers a $5,000 non-refundable income tax credit amount on a qualifying home acquired after January 27, 2009. For an eligible individual, the credit will provide up to $750 in federal tax relief. 

 

This program is administered by the Canada Revenue Agency. Please visit http://www.cra-arc.gc.ca/gncy/bdgt/2009/fqhbtc-eng.html for more information.

 

• Home Buyers’ Plan (HBP)

The Home Buyers’ Plan (HBP) is a program that allows you to withdraw up to $25,000 in a calendar year from your registered retirement savings plans (RRSPs) to buy or build a qualifying home for yourself or for a related person with a disability.

 

This program is administered by the Canada Revenue Agency. Please visit https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/rrsps-related-plans/what-home-buyers-plan.html for more information.

 

• GST/HST New Housing Rebate

You may qualify for a rebate of the GST or HST that you paid on the purchase price or cost of building your new house, on the cost of substantially renovating or building a major addition onto your existing house, or on converting a non-residential property into a house.

 

This program is administered by the Canada Revenue Agency. Please visit https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4028/gst-hst-new-housing-rebate.html for more information.

 

While we’ve listed the programs here, please do remember that the programs themselves and/or the eligibility requirements are subject to change. We recommend visiting the Canada Revenue Agency website as well as speaking with a tax professional for further information, including whether or not you are eligible for these programs.