What Can I Actually Afford?

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Buying a home is a very emotional experience. Similar to when shopping for a car, people often get caught up in the moment and end up with more than they can afford. The difference is that a home generally costs a lot more than a car and is an even longer term investment, so knowing what you can comfortably afford is one of the key first steps in the process.

Also, with interest rates at nearly an all-time low and competition among lenders at an all-time high, it can be very easy to get approval for a mortgage that is more than you can afford.

Qualifying: How much is “normal”?
A good rule of thumb is that most people will qualify for a mortgage equal to about three times their gross annual income. This will give you a very rough idea of what you will qualify for, not necessarily what you can afford. You need to look at your cash flow and determine what makes sense for you.

So, assuming the three times of gross annual income ratio, this means that if you and your spouse each earn a $60,000 gross salary each year, you can, on average, expect to qualify for a mortgage of around $360,000.

Keep in mind, though, that lenders are very particular when it comes to defining gross income. If you work lots of overtime or work in a job where commissions (or even tips) make up a large proportion of your income, you will need to prove that this portion of your income is sustainable. Being able to demonstrate that you have received a certain amount consistently in commissions for the past 2-3 years, for example, will help ensure that this variable income is factored into your mortgage qualification.

Qualifying when you’re a commission earner and/or self-employed
If you are self-employed, the lender will look at your net taxable income over the past 2-3 years as it shows on your Canada Customs & Revenue Agency (“CCRA” - formerly Revenue Canada) Notice of Assessments. These figures are then usually averaged to give an estimate of future income expected.

Unfortunately, most self-employed individuals will find that all the work they did to keep their net taxable income low can have a negative impact on their qualifying for a mortgage. Why is this? Simply put, lenders don't like taking risks and they don’t like the idea of lending to someone whose future income is uncertain. Worse, not only will they look at your income averaged over a time period, but they will often take it one step further by looking at your net income after you have deducted all your expenses for tax purposes.

In other words, a commissioned or self-employed person with $50,000 in gross income would (in most cases) fail to qualify for the same mortgage amount as a salaried employee who makes $50,000 per year, since the commissioned or self-employed individual can write off office expenses, car expenses, cell phones, entertainment, etc.

This means that lots of people who truly can afford a large mortgage have trouble qualifying for that mortgage because they declare very little income for tax purposes.

Now The Good News!
Recently, a few lenders have acknowledged the fact that commissioned earners and the self-employed are actually generally pretty reliable when it comes to repaying their mortgages. New programs cater specifically at these people to allow them to buy a home without showing any, or very little, income. The caveat: these programs usually require a downpayment of at least 10% down of the purchase price and a credit score of 680.

Qualifying – more calculations for the mathematically inclined...
Want to take this one step further? Simply calculate the same two ratios typically used by a lender to qualify you for a mortgage, as follows:

Gross Debt Service Ratio (GDSR): Simply add together your monthly mortgage payment plus 1/12th of annual property taxes plus $75 for monthly heating costs. Divide this sum by your gross monthly income to get your GDSR. Expressed as a percentage, a GDSR is less than 32% is desirable.

Total Debt Service Ratio (TDSR): Similar to the GDSR. Add together your monthly mortgage payment plus 1/12th of annual property taxes plus $75 for monthly heating costs plus any other monthly payments (loans, lines of credits, car leases, minimum payments on credit cards, etc.) Divide this sum by your gross monthly income to get your TDSR. Expressed as a percentage, a TDSR of less than 40% is desirable.

Now, what can I actually afford?
Even though you may be able to qualify for a specific amount for a mortgage, it doesn’t mean that you should apply for that amount. After all, a lot of what you can afford (as opposed to qualify for) is about your lifestyle. For example, if you like to eat out a lot, your ability to afford a certain level of mortgage will be different than someone who eats at home all the time and packs a lunch each day.

So, what’s the best way to approach this? It’s simple: work backwards. Decide just how much you really, truly can afford to pay each month for your “shelter costs” and then work backwards to figure out how much of a mortgage you need. Remember, shelter costs includes your mortgage payment, property taxes, heat, hydro, water, etc.

The bottom line: Be generous when calculating your costs, and be conservative when calculating your income. It is far better to have a smaller mortgage that you can comfortably afford than to be trapped into a larger mortgage that has you stretching every last dollar. After all, there is no fun in getting that dream home but then being unable to afford to furnish it or being unable to leave that house for the occasional night out!

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