How to estimate affordability
There is a rule of thumb about how much you can afford, based on the calculations your mortgage provider will make. The rule of thumb is that you can afford a mortgage where your monthly housing costs are no more than 32% of your gross household income, and where your total debt load (including housing costs) is no more than 40% of your gross household income. This rule is based on your debt service ratios.
Lenders look at two ratios when determining the mortgage amount you qualify for, which generally indicate how much you can afford. These ratios are called the Gross Debt Service (GDS) ratio and Total Debt Service (TDS) ratio. They take into account your income, monthly housing costs and overall debt load.
The first affordability guideline, as set out by the Canada Mortgage and Housing Corporation (CMHC), is that your monthly housing costs – mortgage principal and interest, taxes and heating expenses (P.I.T.H.) – should not exceed 32% of your gross household monthly income. For condominiums, P.I.T.H. also includes half of your monthly condominium fees. The sum of these housing costs as a percentage of your gross monthly income is your GDS ratio.
The CMHC’s second affordability guideline is that your total monthly debt load, including housing costs, should not be more than 40% of your gross monthly income. In addition to housing costs, your total monthly debt load would include credit card interest, car payments and other loan expenses. The sum of your total monthly debt load as a percentage of your gross household income is your TDS ratio.
Maximum limits
While the general guidelines for GDS and TDS are 32% and 40% respectively, most borrowers with good credit and steady income are allowed to exceed these guidelines.
The maximum GDS limit used by most lenders to qualify borrowers is 39% and the maximum TDS limit is 44%. Our mortgage calculator uses these maximum limits to estimate affordability.
On July 1st, 2020, the CMHC implemented new GDS and TDS limits for mortgages that it insured, with the new GDS limit for CMHC-insured mortgages becoming 35% and the new TDS limit for CMHC-insured mortgages becoming 42%. However, on July 5, 2021, these updated requirements for insured mortgages were reversed, and the GDS and TDS limits reverted to 39% and 44%, respectively.
The CMHC changes had fairly minimal impact on borrowers, as Sagen and Canada Guaranty, the two other mortgage insurance providers in Canada, did not change their maximum limits. Consequently, mortgage lenders continued to use the old maximum GDS/TDS limits of 39/44 available through these other insurers. The main result of CMHC’s temporary change in requirements was a major loss in market share, which is why the more stringent requirements were reversed in June 2021.
Down payment
Your down payment is a benchmark used to determine your maximum affordability. Ignoring income and debt levels, you can determine how much you can afford to spend using a simple calculation.
If your down payment is $25,000 or less, you can find your maximum purchase price using this formula:
Down Payment
÷ 5%
= Maximum Affordability
If your down payment is $25,001 or more, you can find your maximum purchase price using this formula:
(Down Payment Amount – $25,000)
÷ 10%
+ $500,000
= Maximum Affordability
For example, let’s say you have saved $50,000 for your down payment. The maximum home price you could afford would be:
($50,000 – $25,000)
÷ 10%
+ $500,000
= $750,000
Any mortgage with less than a 20% down payment is known as a high-ratio mortgage, and requires you to purchase mortgage default insurance, often referred to as CMHC insurance (though, as noted above, mortgage default insurance is also provided by Sagen and Canada Guaranty).
Cash requirement
In addition to your down payment and mortgage default insurance, you should set aside 1.5% – 4% of your home’s selling price to cover closing costs, which are payable on closing day. Many homebuyers forget to account for closing costs in their cash requirements.
Other mortgage qualification factors
In addition to your debt service ratios, down payment and cash for closing costs, mortgage lenders will also consider your credit history and your income when qualifying you for a mortgage. All of these factors are equally important. For example, even if you have good credit, a sizeable down payment and no debts, but an unstable income, you might have difficulty getting approved for a mortgage.
Keep in mind that the mortgage affordability calculator can only provide an estimate of how much you’ll be approved for, and assumes you’re an ideal candidate for a mortgage. To get the most accurate picture of what you qualify for, speak to a mortgage broker about getting a mortgage pre-approval.
How to increase your mortgage affordability
If you want to increase how much you can borrow, thus increasing how much you can afford to spend on a home, there are few steps you can take.
1. Save a larger down payment: The larger your down payment, the less interest you’ll be charged over the life of your loan. A larger down payment also saves you money on the cost of mortgage default insurance.
2. Get a better mortgage rate: Shop around for the best mortgage rate you can find, and consider using a mortgage broker to negotiate on your behalf. A lower mortgage rate will result in lower monthly payments, increasing how much you can afford. It will also save you thousands of dollars over the life of your mortgage.
3. Increase your amortization period: The longer you take to pay off your loan, the lower your monthly payments will be, making your mortgage more affordable. However, this will result in you paying more interest over time.
These are just a few ways you can increase the amount you can afford to spend on a home, by increasing your mortgage affordability. However, the best advice will be personal to you. Contact us to help you find a powerful licensed mortgage broker to have a free, no-obligation conversation that’s tailored to your needs and free of charge.