How is affordability calculated for a mortgage?
Mortgage affordability is a measurement of your ability to repay a loan. The higher your mortgage affordability, the more expensive property you can purchase.
Different lenders have their criteria of calculation. But, in general, mortgage affordability is based on your down payment, total household income, monthly debt payments, and monthly expenses.
Let's look closely at the main factors of mortgage affordability calculation.
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The down payment affects your maximum purchase price limit and monthly mortgage payment.
If the home purchase price is less than $500,000, your minimum down payment should be at least 5%. For example, a property that costs between $500,000 and $999,999 requires a minimum down payment of 5% on the first $500,000 of the purchase price and 10% for the portion of the home purchase price above $500,000. But if your dream home price is $1 million or more, the minimum down payment should be 20% of the home price or value of the property (whichever is lower).
If your down payment is less than 20%, it's considered a high-ratio mortgage, and you need to have mortgage default insurance. It is often referred to as CMHC insurance, but actually, mortgage loan insurance may be provided by other companies.
The qualifying credit score for mortgage insurance is 600.
You could either pay the mortgage default insurance premium upfront or add it to the principal mortgage portion of the home loan. The maximum amortization period for a high-ratio mortgage is 25 years. However, if you change your down payment amount for more than 20%, the maximum amortization period may be charged for 30 years.
Lenders usually provide lower rates for insured mortgages because their risks are covered if you default on your mortgage loan. For example, BMO bank includes the cost of mortgage default insurance in the mortgage affordability calculation. As a result, it lets you borrow more (up to 95% of your home value) with a smaller down payment.
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TDS ratio and GDS ratio. Lenders usually use two standard debt service ratios to estimate the affordability of your future mortgage: Total debt service (TDS) ratio and Gross debt service (GDS) ratio.
Under Canada Mortgage and Housing Corporation (CMHC) regulations, your maximum TDS ratio — total debt load — could not exceed 44%. The TDS ratio is calculated by dividing your total annual housing expenses and debt expenses by your gross yearly income.
Total Debt Service Ratio Formula:
Mortgage payments (Principal + Interest) + Property Tax + Heating costs + Other Debt Obligations + Half of your condo fees (if applicable) / Gross Household Income < 44%
Under CMHC regulations, your maximum GDS ratio should be 39% and below. The GDS ratio is computed by dividing your annual housing costs by your gross income.
Gross Debt Service Formula:
Mortgage payments (Principal + Interest) + Property Tax + Heating costs + Half of your condo fees (if applicable) / Gross Household Income < 39%
For GDS and TDS purposes, your mortgage payment may be computed at an interest rate higher than your current mortgage rate.
Note: Your total monthly expenses could not be more than your net (after-tax) monthly income.
Mortgage Affordability calculators consider government stress testing regulations published by the Office of the Superintendent of Financial Institutions (OSFI).
You must be able to afford your monthly mortgage payments if your interest rate increases to be more than the Bank of Canada's five-year benchmark rate of 5.25% and your current or target interest rate plus 2%.
How to improve affordability
Review several pieces of advice on increasing the size of a mortgage you can afford and raising your eligibility for a home loan.
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As a critical component of mortgage affordability, try accumulating more money to contribute. You will save money on interest and mortgage default insurance with a larger down payment. You can use special programs and grants, including the government's Home Buyers' Plan (HBP). In addition, first-time home buyers may withdraw up to $35,000 each from their Registered Retirement Savings Plan (RRSP) to buy, build and maintain the home.
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Settle your debts and loans. Consider paying them off earlier to afford a mortgage. Various debt consolidation solutions are aimed to help you make a new repayment plan with a suitable term and lower interest rate. That could improve your credit score.
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Take a more extended amortization period. It will result in more interest accrues, but your current monthly payments will decrease and be affordable enough to fit your budget.
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Increase your income. Add a co-signer with a sufficient income and a good debt-to-income ratio. Shrink your monthly living expenses.
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Find a better mortgage rate. Look through the different lending options with different mortgage rates and choose the most favorable. It may save you tens of thousands over the life of a loan and lower monthly payments.
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Consider different locations to live in. You may choose several property locations to compare. Cities, towns, and districts have different living costs, which affects property maximum purchase price and home price.
Talk to a mortgage specialist or mortgage broker to look closely at your specific situation and improve your mortgage affordability.
What is a mortgage affordability calculator?
A mortgage affordability calculator is an online tool designed for home buyers to estimate the amount of potential mortgage money. Also, it may help you to compare different mortgage options and decide how to improve your financial situation enough to afford a dream house mortgage.
Why do you need a house affordability calculator?
With a mortgage affordability calculator, you could start the mortgage process. It's easy and fast to input your info and estimate how much mortgage may be comfortable to pay back in your specific financial situation.
When you already have a student loan, lines of credit, personal loan, or credit card debt, it is crucial to calculate the mortgage you can afford to understand if the home loan fits your budget.
As calculators give you a range of potential prices for your home, you can determine what property is affordable for you and start seeking a suitable future home.
For example, you can just choose the type of your potential property — house or condominium — and the calculator computes average costs. Different property types' fees and fixed costs may vary. For a home, you pay property taxes and any renovation and maintenance costs that may occur. A condominium has fixed condo fees and property taxes, but the maintenance costs and building insurance may already be included.
Another option is to improve your mortgage affordability to reach the amount to cover your dream home mortgage. For example, you could change the values you are entering: total household income, debt payments like car payments, amortization period, and down payment, and compare your home purchase price.
Some calculators may compute the home buyers' costs essential to cover. Additionally to the down payment and mortgage default insurance, borrowers should set aside 1.5% — 4% of the home price for closing costs like legal and title fees.
It's also convenient to compare different mortgage options from various lenders with varying mortgage rates to choose the best conditions.
With all the calculations, you may contact a mortgage specialist or broker to discuss your needs, maximum mortgage, interest rate, and monthly payment you could apply.
How to use a mortgage affordability calculator?
Prepare your budget data, finance information, and mortgage details you know.
Select your future property location and type of property (house or condo), and fill in the minimum down payment you plan to make. Next, input your household income plus the annual income of other co-applicants. Next, enter the total amount of the outstanding debt payments (some calculators have lines for car loans and other loan expenses) and home-associated costs (maybe special boxes for heating and water costs, property tax, condo fees, and additional utility costs).
Contact real estate agents or visit the municipality's website if you don't know your housing costs. Property taxes depend on your property market value. Heating costs vary and are determined by your personal needs and home.
You will see the result as your maximum home price. Additionally, you may obtain details such as total mortgage amount (including the mortgage principal and default insurance if necessary) or maximum mortgage amount (down payment, household income, and expenses), potential interest rate and lender, monthly payment amount, and frequency, amortization period.
You may even get a calculation of the total cash amount needed for a down payment, mortgage loan insurance, and closing costs like land transfer tax, lawyer fees, title insurance, home inspection fees, appraisal fees; and total monthly expenses, which include the mortgage payment, property tax, your monthly debt payment (based on your data), utilities, property insurance, phone, cable, internet costs.
For example, suppose you want to buy a home in British Columbia. In that case, your annual income is $100,000, your co-signer's yearly income is $60,000, and the minimum down payment is $70,000. In addition, you have lines of credit and car loans with total monthly debt payments of $700. In these conditions, the mortgage affordability calculator will provide the data that the maximum purchase price is about $717,901 with a monthly mortgage payment of $4,050.
Let's choose other mortgage details: 5-year fixed mortgage term, 25 years amortization period, and stress test's mortgage interest rate — 5,25%. Housing costs such as property tax and heating costs could be already filled out. Your maximum purchase price includes a total mortgage amount of $673,817 (mortgage principal of $647,901 plus mortgage insurance of $25,916). The total cash required is about $86,157, and monthly expenses are $5,617.
