– The big question for young couples just starting out is whether to move
out of that downtown condo unit and borrow to buy a home. This becomes
especially critical if you’re planning a family or if a baby is already on
the way. Those new little people with all their gear take up and amazing
amount of space, and suddenly the need for more room becomes pressing.
So what rule of thumb can you use to calculate the type of house you can
afford so you don’t fall into the proverbial “money pit”? There’s not
really a simple one-size-fits all answer to this question. But as a
starting point, you have to determine how much mortgage debt you can afford
to carry. Because that’s what mortgage lenders will look at. And they’ll
apply some pretty rigorous screens to determine it.
When you apply for a mortgage, your bank or other lender will look at
something called the Gross Debt Service (GDS) ratio and Total Debt Service
(TDS) ratio. These are calculated using factors such as your annual income,
overall debt load, and how much you pay every month for housing costs.
The Canada Mortgage and Housing Corporation (CMHC), which governs the
mortgage market in Canada has a rule that your monthly housing expense –
which is the total of your mortgage principal and interest, tax, and
heating expenses – can be no more than 35% of your gross household monthly
income. This is your gross debt service (GDS) ratio. Your GDS is the ratio
of your total housing costs to your gross monthly income.
In addition, the CMHC rules state that your total monthly debt load (which
includes credit card interest, consumer loans, and car payments), including
housing costs, can be no more than 42% of your gross monthly income. Your
TDS is the ratio of your total of your monthly debt load to your gross
To make matters even more complicated, as of Jan. 1 this year, anyone
borrowing from a lender subject to federal regulation (and that includes
just about every financial institution in Canada) will have to pass the
OSFI Mortgage Stress Test in order to be approved for a mortgage. And note,
this now applies to all borrowers, including those making down payments of
20% or more, who typically don’t need mortgage insurance.
Applied to the loan application, the stress test will look at such things
as how much you’ll be able to afford with your current debt-to-income
ratio, and whether you’d be able to continue making payments if interest
rates rise or you lose your job. But the kicker is that even if you qualify
for a mortgage at a current contracted rate today, you’d still have to
qualify for a mortgage at an even higher rate, which is calculated as your
current rate plus two percentage points, or the average posted 5-year bank
rate, whichever is higher.
Working from these ratios, you’ll be able to determine how much mortgage
you can afford to carry. Most younger couples just starting out will not be
able to afford a single-standing home in the downtown areas of larger urban
centres. At least not without stretching their budget to the breaking
point. In addition, you’ll have to budget for monthly maintenance and
upkeep costs of your home – costs that were buried in your monthly rental
payment, but which will now come out of your own pocket – in addition to
your mortgage payment.
So how do you cut the cost of buying a home? First, make as big a down
payment as you can. Borrowing a smaller amount means paying less interest
over the term of the mortgage, which can add up to tens of thousands of
dollars in savings. Another way is to set up weekly payments on your
mortgage. This means that more of your payment is quickly applied to
principal. Take advantage of any annual principal prepayment options, which
allows you to make specified annual lump-sum payments directly against the
principal amount. Again, cutting the principal is important, because you’ll
be paying off your debt faster and reducing your interest costs
The offset to the tidal wave of costs involved in buying and owning your
own home is that property values tend to increase over the longer term, at
least by the rate of inflation, and often by quite a bit more depending on
the location of your home. And with every principal payment, you’ll be
adding to your equity, which means that each month, the bank owns less and
you own more of your home.
Don’t forget that there are numerous closing costs involved with real
estate transactions, including legal fees. These can soar to several
thousand dollars depending on the size of your purchase. Try to find out in
advance how much these will be, from your real estate agent or lawyer, and
make sure to budget for these so you don’t get caught short.
Buying your first home is a big decision. If you’re having trouble
deciding, a qualified fee-for-service financial advisor can always help
bring you back to earth and decide what’s really affordable for
Robyn Thompson, CFP, CIM, FCSI, is the founder of
Castlemark Wealth Management, a boutique financial advisory firm specializing in wealth management
for high net worth individuals and families. Contact her directly by
phone at 416-828-7159, or by email at
for a confidential planning consultation.
Notes and Disclaimer
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