How much money do you have?
The first factor in the calculation is your down payment. In Canada, homebuyers must be able to provide at least 5% of a home’s purchase price upfront if the place costs $500,000 or less. If the place costs more than $500,000, tack on another 10% of the excess. If the place costs more than $1 million, you need to put down 20%.
Regardless of the price of the home, if you don’t have enough savings to put 20% down, you’re labelled a risky “high-ratio” buyer. That means your lender is forced to buy mortgage default insurance that will protect them in case you go broke and stop paying. The cost of that insurance premium will be passed on to you in the form of larger mortgage payments.
If you were thinking of using a loan or credit cards to make a down payment, you’re out of luck. Canada Mortgage and Housing Corporation (CMHC) rules that came into effect July 1, 2020 say “non-traditional sources of down payment that increase indebtedness” are no longer OK.
First-time buyers can lean on the federal Home Buyers’ Plan, which allows you to borrow up to $35,000 (or $70,000 for couples) from a registered retirement savings plan (RRSP) to purchase your first home.
Once you’ve got your down payment ready, don’t forget to budget for closing costs. A lot goes into finalizing a deal on the house market, including lawyer fees, land transfer taxes and title insurance. The total could land anywhere between 1.5% to 4% of your home’s price. On a $500,000 home, that means you might need an extra $20,000 in the bank.
And after all that, you still need money to eat and enough cash in your emergency fund to weather an unexpected expense or job loss. Even if you’re making good money, you may need to save up for quite a while.
How much money do you earn?
The second factor is your total monthly mortgage payments.
You’ll face firm restrictions here if you need your mortgage insured by the CMHC, but you probably want to stick within these limits regardless. If you’re “house poor” and up to your ears in debt, you can forget about saving for retirement, paying for your car or going on a vacation.
The two numbers to know are your Gross Debt Service (GDS) ratio and Total Debt Service (TDS) ratio.
Your GDS is the percentage of your gross income that you spend on housing, including mortgage payments but also utilities, condo fees and property taxes. The CMHC caps your GDS at 35%, meaning your housing expenses shouldn’t drain much more than a third of your income.
Your TDS includes your housing expenses but also all of your other debt, like credit card payments and car payments. The CMHC will refuse to insure your mortgage if your TDS exceeds 42% of your annual income.
Even if you’re not bound by CMHC rules, keep these limits in mind when deciding for yourself whether a home is affordable.
How do lenders decide what to give me?
When assessing you for a mortgage loan, lenders look at your financial status and history when deciding how much money to lend you and at what interest rate. Can you be trusted to pay off your debts? That’s the million-dollar question.
Expect lenders to look at your credit score and maybe your credit report, too. The CMHC asks for a minimum credit score of 680 from those in need of default insurance, but lenders want to be impressed. The higher your score, the more reliable you appear, so check your score for free online and take steps to improve it.
They’ll also look at your annual income and debts (that is, your GDS and TDS) to see whether you’re taking on more than you can financially handle. Lenders also prize stability; in their eyes, an ideal borrower isn't a self-employed freelancer but an employee who has worked for the same company for more than two years.
A good rule of thumb is that you can expect a lender who likes you to offer a mortgage up to four times your gross annual income. So if you make $50,000 a year, you might get a loan of up to $200,000. You’ll also get a better mortgage rate than your competition.
Just remember, there’s a difference between “How big of a mortgage can I get?” and “How big of a mortgage can I afford?” Just because a lender will give you a big sack of money doesn’t mean you can afford to take the whole thing.
How to make a mortgage more affordable
No matter how good you look as a borrower, your mortgage will be a serious drain on your finances. You’ll want to explore every avenue to keep costs down:
Provide a larger down payment, if you have the cash. When you pay more now, you have a smaller mortgage to pay off and thus lower monthly payments. And if you put down 20%, you won’t have to worry about mortgage default insurance or CMHC restrictions.
Consider the First-Time Home Buyer Incentive. This program gives the federal government a cut of your home in exchange for cash to put toward the down payment. Not everyone considers it a good deal, however.
Extend your amortization period. By giving yourself more time to pay off your mortgage, you won’t have to pay nearly as much each month. You will end up paying a lot more in interest in the long run, but your payments will be more manageable while you deal with other expenses.
Go a-hunting for a better deal. Don’t just go to your local bank and accept whatever interest rate they offer you. Shop around and get quotes from many different lenders, because even a fraction of a percentage point can save you buckets of money month after month.
If you don't have time to hunt for the best mortgage yourself, get Homewise to work the market for you. This online brokerage will negotiate on your behalf with more than 30 big banks and other lenders, completely free, and it only takes five minutes to apply.