Choosing the right mortgage can be a complicated process. With all of the options available to potential homebuyers, it can be a challenge to figure out what mortgage you can afford with your current income, savings, and equity.
Many potential homeowners use online mortgage affordability calculators to give them an idea of the mortgage they can afford, but these tools should be used with caution. Most mortgage calculators will only account for a limited number of variables that actually go into calculating the mortgage — to get a better idea, you should consult with a professional.
In this article, we will go over some of the factors that may influence the size of mortgage that you will be able afford, from external components like government regulations to individual considerations like your income and credit score. In each section, we’ve broken down what you need to know about to start answering the question: “what mortgage can I afford?”
When calculating the mortgage you can afford, it’s important to consider maximum affordability. In Canada, you must be able to afford to pay a down payment of a certain percentage based on the cost of the home.
- Homes under $500,000 require a minimum down payment of 5%
- Homes between $500,000 and $1 million require a minimum down payment of 5% on the first $500,000, plus 10% of the remaining balance
- Homes above $1 million require a minimum down payment of 20%
Paying the minimum required down payment will qualify you for some mortgage, but if you can, we recommend paying more than the minimum down payment to reduce costs from mortgage insurance, monthly mortgage payments, and more. In the long-term, a larger down payment may increase what home you’re able to afford.
If you are having trouble paying for the home of your dreams, there are other ways to increase what you’re able to afford in the future. For example, you can start paying off your debts or find jobs that will increase your income.
Gross Debt Service (GDS)/Total Debt Service (TDS)
Once you’ve done all you can to maximize your mortgage affordability, you’ll need to determine whether you can afford the monthly mortgage payments. The Canadian Mortgage and Housing Corporation (CMHC) has the following calculation for determining whether you can afford your monthly payments:
GDS <35% = monthly payments + property taxes + heating costs + 50% of condo fees (housing expenses) / annual income
TDS <42% = housing expenses + credit card interest + car payments + loan expenses / annual income
Your Gross Debt Service (GDS) is simply your overall housing expenses, divided by your annual income. To calculate your housing expenses, the CMHC will take your mortgage payments, property taxes, heating costs, and any condo fees (where applicable) to calculate what you will typically spend in one year. This ratio should be above one third or 35% to qualify for a mortgage.
Your Total Debt Service is your total housing expenses from the previous calculation, plus any potential debts or credits, divided by your annual incomes. These potential debts or credits may include credit card interest, car payments, or other loan expenses. This ratio should be above 40% to qualify for a mortgage.
Income & Credit Score
Your annual income or salary is essential for calculating your mortgage affordability and your GDS/TDS, but your credit score can be just as important. If your credit score is low (between 300 and 650), this will typically require you to pay higher mortgage rates.
For example, new immigrants to Canada will start off their credit rating at 300 and will need to build up their credit score before being able to qualify for lower mortgage payments. Other people may have bruised credit ratings due to missed debt or credit payments.
Many Alt-A or B lenders offer options for people with low credit scores. At Main Street, we recognize that your credit score is not always a fair reflection of you.
All homes in Canada will require a minimum down payment of 5% to 20%, depending on the cost of the house. If you are able to pay more than the minimum down payment, this can help you qualify for a larger mortgage, increase your maximum affordability, and purchase a more expensive home.
However, this is just one of the ways that your down payment can impact your mortgage affordability. Your down payment also influences your CMHC insurance and your monthly mortgage payments, which we will discuss in more detail below.
Mortgage Default Insurance
Mortgage default insurance is mandatory in certain situations. If your down payment is between 5% and 19.99%, you are required to purchase mortgage default insurance. Any mortgage where you are required to purchase insurance is known as a high-ratio mortgage.
If your down payment is above 20%, this is known as a conventional mortgage. No mortgage default insurance is required for conventional mortgages. All mortgages on homes over $1 million will be conventional mortgages, as a minimum down payment of 20% required for these purchases.
Mortgage default insurance is provided by three providers in Canada: the Canadian Mortgage and Housing Corporation (CMHC), Genworth Canada and Canada Guaranty. It will typically cost from 2.8% to 4.0% of your total mortgage.
Mortgage insurance allows people who would not otherwise qualify for a mortgage to buy a home. It keeps the risk for the mortgage lender low, since they are insured against potential defaults, and keeps mortgage rates low as a result.
The cost of your home isn’t fully realized until you take closing costs into account. Closing costs include a number of fees that result when you commit to purchasing a home, which can add up to range from 1.5% to 4.1% of the selling price. These fees include:
- Legal and administrative fees
- Home inspection (includes testing for septic tank, well, etc.)
- Land transfer tax
- Title insurance
- PST on mortgage insurance
- Property insurance (must be in place on closing day)
- Prepaid utility bills
- Property tax
When determining your budget for your home, it’s important to keep closing costs in mind so there are no surprises when you finalize your purchase.
The CMHC sets your monthly mortgage payments according to your mortgage amount, mortgage rate, amortization period, and payment frequency. You can choose to pay your mortgage monthly (as most homeowners do), biweekly, and even weekly.
Your amortization period is typically no longer than 25 years if you paid a down payment of less than 20% — in fact, 80% of Canadians choose a 25-year amortization period. However, if you paid a down payment of more than 20%, you have more flexibility and most lenders will allow you to extend your payment period.
Your mortgage rate is also dependent on the type of plan you choose: variable or fixed-rate. A fixed-rate mortgage allows you to pay the same monthly payments for the entirety of your mortgage, and won’t be impacted by rising interest rates. Variable mortgages are typically recommended for people who don’t plan on staying in their home long-term and provide them with lower interest rates.
At Main Street Mortgage, we can not only help you determine how much mortgage you can afford, but we can help you find the best mortgage for you.