As you get ready to purchase your new home, you naturally start looking at homes currently on the market and visiting showhome parades. You also know that your mortgage payment is probably going to be your biggest expense, so you need to find a home that’s in your price range. A mortgage affordability calculator can help you estimate how much home you can afford but you need to have a good understanding of how mortgages work to use them correctly.
Our quick guide should help you get a sense of how much you’ll be able to spend on your home.
A Quick Calculation
If you’re just looking for a quick estimate of what you can afford, simply multiply your annual salary by 2 or 2.5. For instance, a person earning $50,000 per year should be able to afford a home worth $100,000 to $125,000 and a person earning $200,000 per year should be able to afford a home between $400,000 and $500,000. Remember, couples buying a home together can combine their income.
While this method can give you a general idea, it’s far from accurate. It's best to start the homebuying process by getting a more specific number from a bank or mortgage broker.
Understanding Your Monthly Mortgage Payment
Many first-time homebuyers are surprised to learn the mortgage figure you get from a bank isn’t based on the total amount you can borrow but the total amount they think you can pay each month. That’s because they consider your monthly mortgage payment to include a portion of your annual property taxes, annual homeowners’ insurance premium and mortgage insurance in addition to the loan payment.
Those additional payments might add a few hundred dollars to the monthly payment, so you need to factor them in when you’re searching for homes. Only use a mortgage calculator that includes these figures.
What Banks Want
Banks look at the debt-to-income ratio (DTI) when they decide how much to lend. In general, a mortgage lender will use 28 percent of your monthly income as the maximum proportion going towards the mortgage payment. A couple earning $150,000 would likely qualify for a monthly mortgage payment of around $3,500. Remember, this monthly payment needs to include taxes and insurance.
Furthermore, the bank will also look at your debt load. Ideally, they want your total debt payment – including the mortgage and any other bills you might have – to be less than 36 percent of your monthly income. For the same couple earning $150,000, the total monthly debt payment shouldn’t exceed $4,500. A couple without much debt would still be able to qualify for the mortgage payment of $3,500. However, if the couple’s monthly payments are $500 for student loans, $400 for auto loans, and credit card payments totaling $500, they’d only qualify for a mortgage payment of $3,100.
Budgeting For Your New Home
The bank will set a maximum monthly payment for you but you also have to be smart about setting your own budget. The bank only looks at your mandatory debt spending. It doesn’t include the little extras you choose to spend money on. If you enjoy taking extravagant vacations, paying for services or memberships with high monthly rates, or just spend a lot of money eating out, the monthly payment the bank allows may be too high. Take an honest look at your spending habits as you determine what’s affordable to you.
Making Homeownership More Affordable
Many excited first-time homebuyers are disappointed when they see how much home they can afford based on the bank’s recommendation. They discover the home they want is more than the bank thinks they can afford. Fortunately, there are options out there.
One way to improve affordability is to reduce the principal mortgage amount. The easiest way to do this is by saving for a larger down payment. You can do this by continuing to save up for another year or two before making your purchase. You might also be able to borrow up to $25,000 from your RRSP ($50,000 for a couple). If you do this, you’ll have to repay that money within 15 years. The bank’s DTI calculations will include this new monthly payment, but it’s an option that works for many people.
You can also choose to purchase a more affordable home. You might have to make some compromises to do this. For instance, you could buy a smaller home, you could choose a home design that doesn’t have all the bells and whistles you really want or you could pick a neighbourhood that’s a bit further from your ideal location. As you make payments on this home, you’re building up equity. If you’re ready to upgrade in five to ten years, you can use that equity toward the new down payment and you’ll have enough to qualify for the home you want. Many believe this is a smarter choice than paying rent.
StreetSide offers a variety of affordable brand-new homes for first-time homebuyers. Come check out our show homes to see what your life could be like.