The affordability of mortgages has been a hot topic in Canada. The real estate market has exploded in recent years. Prices have come down slightly recently, but paying a mortgage is still a very difficult task for many Canadians.
How much of a mortgage can you afford? To determine this, I suggest going directly to the source: the Canadian Housing and Mortgage Corporation (CMHC).
The CMHC is the Crown corporation that is Canada’s national housing agency, so there is no better source for this information. There are a few ways to determine how much mortgage you can afford. Let’s start with the easiest method.
The Easy Method: Use CMHC Calculators
This is the best way to find out how much of a mortgage you can afford, as CMHC is the official source and will have the most up-to-date information.
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Step 1: If you don’t know your monthly mortgage payments yet, you can calculate them using the CMHC Mortgage Calculator. You will need to enter the home’s purchase price, down payment, amortization period, mortgage interest rate, and payment frequency. If you already know the monthly payments, you can skip this step and go to the next one.
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Step 2: Go to the CMHC Debt Service Calculator, where you will need to enter your annual household income (before taxes), monthly mortgage payment (from step 1), monthly heating expenses, monthly property taxes, and other fees such as condo fees and rental fees and association fees, if applicable. This is to calculate what is known as the gross debt service ratio (GDS), which cannot exceed 39 percent.
Then, if applicable, you’ll need to complete monthly payments on your credit card debt, auto loans or leases, and loans and lines of credit. This is to calculate your total debt service (TDS) ratio, which cannot exceed 44 percent.
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Step 3: If you do not receive an error message and are within the GSD and TDS limits, you will most likely be able to pay your mortgage and can continue to shop for mortgage rates.
If you get an error message that says your GDS has exceeded 39 percent, or your TDS has exceeded 44 percent, you may need to lower your monthly mortgage payment amount. Common ways to do this are by making a larger down payment, buying a cheaper home, or reducing your other sources of debt. You can also increase your income, which is usually more difficult to do!
The hardest method: Calculate everything yourself
To find out how much mortgage you can afford, you can always calculate your GDS and TDS yourself. The formulas are not too complex, but it is a bit tricky. This is how you calculate it:
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Gross Debt Service Ratio (GDS)
(Mortgage payments + property taxes + heating costs + 50 percent of condo fees)
÷ annual income
= GDS ratio (must be < 39 percent)
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Total Debt Service Rate (TDS)
(Housing expenses (use GDS numbers) + credit card interest + car payments + loan expenses)
÷ annual income
= TDS ratio (must be < 44 percent)
The minimum down payment you’ll need to make is 5 percent of the purchase price up to $500,000, plus 10 percent of the cost between $500,000 and $1 million. If you have a home that costs more than $1 million, you’ll need to put down a 20 percent down payment.
If your down payment is less than 20 percent of the purchase price, you’ll need mortgage insurance on your loan, and that will be an additional premium placed on your mortgage. Mortgage insurance is only available for properties whose purchase price is less than $1,000,000.
Some ways to lower your mortgage payments
While the following may not reduce your overall mortgage, it could potentially reduce your mortgage payments or duration.
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How to find a better mortgage rate:
- Look beyond the big banks: Mortgage brokers can be very helpful as they access multiple lenders.
- First, find a mortgage broker that has good reviews in your area.
- You can contact several mortgage brokers by phone or email to see what rates they will give you. You can accomplish this through a quick 15-minute phone call or by sending an email to several different mortgage offices.
- Good brokers should get back to you very quickly, and you can compare your options and go over any questions you have with them.
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Negotiate with your real estate agents:
- You may be able to find a real estate agent who is willing to lower their commission rates so you can save a bit on the purchase price, especially if you live in higher demand markets.
Consider keeping your mortgage below the maximum you can afford. By doing so, you will have more options in the future if something goes wrong with your financial situation.
Christopher Liew is a CFA Charterholder and a former Financial Advisor. He writes personal finance advice for thousands of daily Canadian readers on his Awesome Wealth website.