If you’re in the market to buy a home in Canada, you may be trying to figure out what purchase price you can realistically afford. But the real question you should be asking is: How much mortgage can I afford?
Indeed, since most of us don’t have enough cash on hand to buy a property outright, knowing your mortgage affordability is a critical first step in determining how much you can spend on a home.
But what exactly is mortgage affordability, and how is it calculated? We cover it all below—and provide a mortgage affordability calculator that can give you a ballpark maximum loan amount to consider before you consult a lender.
What is mortgage affordability?
Mortgage affordability is the term used to describe how much money a bank or other financial institution will lend you for a home purchase. Mortgage lenders use several factors to determine your mortgage affordability.
These factors include household income, living expenses, debt level, credit score, and the size of your down payment. Interest rates also play a major role in mortgage affordability—generally the lower the rate, the more you’ll be able to borrow. In a nutshell, your mortgage affordability will determine how much house you can buy.
What Impacts Your Mortgage Affordability
If you want a better understanding of the way these rates, and other factors, contribute to your mortgage affordability, read the section below.
Income, expenses, and debt
Lenders take a holistic view of the money you’ve got coming in and going out to make sure you can afford not only your mortgage payments but also all your other housing and debt-carrying costs. There are two general guidelines that lenders apply in this calculation:
- Gross debt service ratio (GDS): The GDS guideline stipulates that the annual total of your mortgage payments, property taxes, heating costs and half of any condo fees must not exceed 32% of your gross annual household income. In other words, if your yearly pre-tax household income is $100,000, you could not spend more than $32,000 annually for all those housing costs (mortgage, property taxes, heat, and condo fees).
- Total debt service ratio (TDS): TDS takes all of the above and then also adds any debt service payments you might have—including for student loans, credit card debt, car loan, etc.—and sets a threshold of 40% of pre-tax household income. So, using the example above of $100,000 gross income, all housing costs plus debt carrying costs could not exceed $40,000 a year.
Some lenders may extend GDS to 39% and TDS to 44% for preferred borrowers with good credit.
Lenders look at your credit score to decide if you’re a good or bad risk.
If you have a high score (690 or higher), they will feel confident that you will make your payments on time and are more likely to offer you a favourable interest rate.
If you have a below-average credit score (600 or lower), financial institutions see you as a risk and will either refuse to loan you money or will charge you a high rate of interest.
This is important because the rate of interest you are offered can be a major factor in your mortgage affordability—especially if you have less-than-ideal credit, as we’ll explain next.
Because interest rates have been very low for the past few years, the federal government introduced what’s called a “mortgage stress test” to ensure borrowers can still afford their mortgage payments, even if rates rise in the future.
What this means is that lenders must use a higher interest rate than what borrowers qualify for when determining the size of their mortgage. More specifically, your qualifying mortgage loan amount will be calculated based on either a fixed rate of 5.25%, or the interest rate on offer from your lender plus 2%, whichever is higher.
For example, let’s assume a lender determines that you can afford to spend $30,000 annually (or $2,500/month) on mortgage payments based on your income using the GDS and TDS guidelines.
If your credit score is excellent and you are offered a five-year fixed rate of 1.79%, your qualifying loan amount would therefore be based on the 5.25% rate.
Assuming a 25-year amortization, you could borrow up to $419,500 and keep your mortgage payments within the $30K annual ($2,500/month) limit, even if interest rates went up to 5.25%.
If, however, your credit score isn’t as good and you’re offered a five-year fixed rate of 5%, your qualifying mortgage amount would be calculated at 7% (5% + 2%). In that case, the maximum you could borrow to stay within the $30K annual ($2,500/month) mortgage payment limit would be just $356,900, assuming a 25-year amortization.
It’s important to understand that the stress test calculations are used only to determine your borrowing eligibility. Your actual mortgage payments will be calculated based on the interest rate on offer. The lower the rate the less you’ll pay, as shown in the chart below.
|Borrower’s monthly payment affordability maximum||Offered rate||Qualifying rate for loan eligibility||Max. mortgage loan*||Monthly mortgage payment*|
|*Based on a 25-year amortization|
Down payment amount
Canadian mortgage rules specify that you must put down at least 5% on any home that’s up to $500,000 in value, and no less than 20% on homes of $1 million or more. When the purchase price is somewhere in between, you’ll need 5% on the first $500,000 and 10% on the rest.
(If you want to avoid the extra costs of CMHC mortgage loan insurance, you’ll have to put down a full 20% regardless of the purchase price.)
In real dollar terms, that means you’ll need a down payment of at least $25,000 for a $500K home; $50,000 for a $750K home; and $200,000 for a million-dollar home.
So, how does this all affect your mortgage affordability?
Let’s take a look at our example above where you qualified for a maximum mortgage loan of either $420,000 or $357,000, depending on your credit score and interest rate offered.
If you have only $15,000 saved up for a down payment, those calculations don’t apply. Instead, the most you could spend on a property is $300,000 (because you must put down at least 5%; and $15K is 5% of $300K) so your maximum mortgage loan would be $285,000 ($300K – $15K).
In other words, even if you’re a high-income earner with little to no debt and excellent credit, your borrowing power will be limited if you don’t have enough saved for a down payment.
Ways to increase your mortgage affordability
Now that you’ve seen how lenders determine the amount you can borrow for a home purchase, it shouldn’t surprise you to learn that you can boost your mortgage affordability by tweaking those factors, as explained below.
Save more for a down payment
If you don’t already have the requisite percentage saved up for homes in your price range, check out our tips on how to save more for a down payment.
One option available to first-time buyers is to borrow up to $35,000, tax-free, from a Registered Retirement Savings Plan. If you’re buying a home with a partner or spouse, each of you can withdraw that sum from your own RRSPs under the Home Buyers’ Plan, for a total of $70,000.
Improve your credit score
If lenders are currently offering you a mortgage rate higher than 3.25%, taking steps to boost your credit score may improve your mortgage affordability. A better credit score translates to lower interest rates, and under the new mortgage stress test rules you want to make sure the rate on offer, plus 2%, does not exceed 5.25%.
Shop around for a better interest rate
They consider your housing needs, credit history, preference for a variable or fixed or open or closed mortgage, and then negotiate to get the most competitive mortgage interest rate on the market.
Pay off debt
If your total debt service ratio exceeds 40% of your gross household income, you may be able to increase your mortgage affordability by paying down some of your debts, especially expensive high-interest debt such as outstanding credit card balances.
Obviously, the above methods will only work if they fit your circumstances. For example, if you’ve already got a preferred interest rate, improving your credit score won’t do much to increase the size of the mortgage loan you qualify for.
Similarly, paying off debt won’t improve your mortgage affordability if your debt-to-income ratio is already within the TDS guidelines. Of course, shopping around for a better interest rate and saving more for a down payment are always advisable, regardless of how it affects your loan eligibility amount.
Remember: you can’t figure out how much to spend on a home without first determining how much mortgage you can afford.
Input your income, debt payments, credit score range and qualifying interest rate into our mortgage affordability calculator to get a rough estimate of the size of the loan you are likely to qualify for or use the explanations provided to crunch the numbers yourself.
If you’re not happy with your mortgage affordability, you may be able to qualify for a larger loan by increasing your down payment, shopping around for a better interest rate, or improving your credit score, and/or paying down debt. Try tweaking the figures in the calculator first to see which options are most likely to help, based on your individual circumstances.
Then take the appropriate steps to increase your mortgage affordability, and reap the rewards.