How Much House Can I Afford?

There’s an important difference between how much house can I get approved for, and how much house can I afford?  Your mortgage payments should be low enough so you can take care of your monthly expenses, meet your savings goals and still have a bit of fun.

Remember, it’s not just a mortgage payment you have to deal with; there’s property taxes, home insurance, heating costs, lawn care and maintenance – it all adds up.

Related: 4 Hidden Costs When Buying And Selling Your House

When too much of your household income is spent on home ownership and you don’t have enough cash left over for discretionary purchases, that means you’re house poor.  Sooner or later, house poor families have trouble meeting their other financial obligations, which can lead to trouble.

Ask yourself how much house you can truly afford without taking up most of your disposable income.

How Much Will The Bank Lend Me?

Some lenders have different criteria for approving your mortgage.  Before applying for a mortgage, you should compare lenders or have a qualified mortgage broker do so on your behalf.  You want to get the amount and terms you’re looking for, as well as the best available interest rate.

Related: Shopping For Mortgage Rates: Fixed Vs. Variable

To figure out how much mortgage you can qualify for, lenders use your Gross Debt Service Ratio and Total Debt Service Ratio.

Gross Debt Service Ratio is used to calculate the amount you can afford to spend on mortgage principal and interest.  Some lenders might include property taxes and heating costs as well.  These expenses are added together, and generally should not exceed 32% of your income.  If you have no other monthly debt obligations, some lenders will go as high as 40% for the Gross Debt Service Ratio.

Most people do have monthly financial obligations other than mortgage payments and taxes, so lenders want to know about them so they can determine your ability to pay your mortgage.  Using the Total Debt Service Ratio, the lender wants to know all your fixed monthly debts.  This can include credit card payments, student loan payments, car payments, and condo fees.

In general terms, no more than 40% of your gross family income can be used when calculating the amount you can afford to pay for principal, interest and taxes, plus your fixed monthly debts.

Obviously, the lender is most concerned about minimizing the risk that you will be unable to meet your financial obligations if the ratio is too high.  Notice that this ratio doesn’t include your savings obligations – just debt.

How Much House Can I Afford?

Again, instead of focusing on traditional lending ratios to determine how much house you can afford, it’s important for you to consider all your monthly obligations.  This includes other home expenses like utilities and maintenance, as well as daily living expenses like groceries and gas.

Finally, think of your savings as a fixed expense.  If your goal is to save 10% of your income, make sure to include it in your own ratio to determine how much house you can afford.

Call it the Total Financial Obligation Ratio.  Let’s do the math, aiming to keep this amount under 40%:

Gross Household Income

  • $6,500/month

Savings Obligations

  • Emergency Fund – $100/month
  • RRSP – $300/month
  • TFSA – $250/month

Debt Obligations

  • Car payment – $350/month
  • Student loan – $100/month

Your total financial obligations add up to $1,100 a month, so that means you can afford to spend $1,500 a month on mortgage and taxes and still meet your savings goals.

Related: Our Fast Track To Financial Freedom

Now let’s say you have $50,000 for a down payment and can get an interest rate of 3.2%.  When I plug these numbers into one of the big banks’ mortgage calculators to see how much house I can qualify for, it comes up with a purchase price of $414,000.  That’s because the bank only takes into account the $450 a month debt service in addition to the mortgage payment and taxes.

But when I plug $1,100 a month into the debt obligation field, the calculation is much different.  The maximum house price you can afford is now only $295,000.

Final Thoughts

We did this exact calculation when we wanted to build a new house.  Unfortunately, we weren’t thrilled with what our total financial obligation ratio said we could afford – which was somewhere around $300,000.  The house we wanted to buy was selling for $395,000.

Sure, we could have stretched our budget by taking a higher amortization and borrowing the maximum our bank would lend.  But we were kidding ourselves if we thought we could afford this house.  Instead, we did something unconventional by today’s standard – we waited.

We saved and paid down debt as much as we could for over a year.  Then, once we saved up 20% for a down payment, eliminated most of our monthly debt obligations, and had a savings plan in place, we finally pulled the trigger and bought a new house.

Related: First Time Home Buyer – HBP Or TFSA?

When you’re ready to buy a home, keep in mind the difference between how much house can I qualify for, and how much house can I afford.  Try using the total financial obligation ratio before meeting with your lender to see how much the difference really is.

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  1. Liquid on August 13, 2012 at 3:06 am

    Great reminder. I will be looking into these ratios soon because I’m planning to purchase a 2nd property. Lots of people still get confused lol, but it’s important to know the difference between what we Can borrow, and what we Should borrow. Do you think it would be more accurate if banks used net income, instead of gross income, to calculate service debt ratios? It’s always good to do your own calculations like you showed here anyway.

    • Canadian Mortgage on August 13, 2012 at 9:57 am

      Calculation of GDS TDS based on net income would be a problem as the tax levels are different.
      Rather the lenders and the borrowers should better understand the risk they are taking.

      If you can borrow $50,000 on your credit card should you borrow that amount because you are eligible?

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