My husband and I purchased our first home when we were 23 and 21 respectively. Back then the mortgage approval process used all of his income but only 50 percent of mine.
Income requirements have changed since then. If both spouses (or common-law, or other applicant) are working, the total of both incomes is utilized and lenders use debt ratios to determine how much of a mortgage payment you can afford.
Can you really afford that mortgage?
Gross Debt Service (GDS) is the percentage of the borrower’s gross income(s) required to cover monthly housing costs. These costs consist of the mortgage payment (principal and interest), property taxes, heating and (if applicable) 50 percent of condo/strata fees.
Total Debt Service (TDS) considers all other debt obligations – student loans, consumer loans, and credit cards – in addition to housing costs.
Banks typically use a 32 percent ratio for GDS and 40 percent – 42 percent for TDS.
But, remember, this is based on gross income. What are your other expenses? Income tax for one, other payroll deductions, insurance payments, utilities, food and clothing, perhaps child care, RRSP and other savings contributions, not to mention ongoing maintenance for your new home.
Sure, get your mortgage pre-approval, but do your own calculations before house hunting. Decide realistically how much you can pay for your house monthly – and be sure to include an emergency fund for the inevitable furnace breakdown, or leaky dishwasher.
Here’s a good calculator from TD that lets you include other general expenses you may have so you can determine how much of a mortgage you can afford.
Interest rate hikes are not the only risk
There have been streams of articles for almost a decade warning about how higher interest rates will cause massive mortgage defaults. How worrisome is that threat really?
This past July, the rate hike finally came to pass with a 0.25 percent increase in the Bank of Canada’s key interest rate. This will affect variable interest mortgages and home equity lines of credit as the banks raised their prime rates.
Most people should be able to handle a small increase in their payments.
On a mortgage with a 20-year amortization, a 0.25 percent interest hike will increase a monthly payment by less than $40 on a $300,000 mortgage, and just over $50 on a $400,000 mortgage balance.
The bigger danger
If your mortgage payment was based on the maximum allowable by your financial institution, the bigger danger is what could happen if you lost income from a job layoff, or maternity leave.
Before committing, factor in possible changes you expect in the future. You may want to replace your car in a few years. If you are thinking of starting a family, think of the impact of maternity leave as well as all those expenses related to children.
Keep in mind that debt service ratios shouldn’t be the only way to determine whether your debt load is manageable. They don’t take into consideration everyday expenses. You may struggle even if you are below the maximum. You don’t want to be burdened by housing costs, plus it will affect all other parts of your spending and savings plan.
Be realistic about how much house you can afford to buy. Put down the biggest down payment you can afford and don’t be in a big hurry to significantly upsize if your financial situation improves.
As for us, we lived on my husband’s salary and I banked most of mine for our down payment. So, when baby number one arrived shortly before our home was completed, we were able to manage just fine.