Buying a new home is an important lifestyle choice – you decide where you want to live based on the type of home you want, the neighbourhood, perhaps proximity to schools or parks, and for a host of other personal and family reasons. But first and foremost, you must correctly answer this key question: How much house can I afford?
That’s an easy question to ask but there are no easy answers. Lenders typically use two formulas to determine the maximum loan they are prepared to offer you. The first is known as the Gross Debt Service Ratio (GDS) which requires that your housing costs are not more than 30% of your gross (before-tax) monthly income. The GDS calculation includes mortgage principal and interest payments, property taxes, 100% of expected heating costs, secondary financing (if applicable), as well as 50% of condominium fees (if applicable).
Only assured income sources count in the calculation. Variable income, such as tips, bonuses or overtime earnings do not count – but two-income households can use a combined ‘family’ income amount.
The second lending formula is known as the Total Debt Service ratio (TDS). It takes into account other debts, such as car payments and credit card payments. No more than 40% of your gross (before-taxes) monthly income can be allocated to your housing costs and other monthly debt obligations such as credit card payments, loans and so on.
These calculations create the foundation for the amount of mortgage you qualify for – but by themselves, they do not necessarily give you an accurate assessment of the mortgage amount you can carry.
To do that, you have to look at your total financial picture – from the taxes you will pay, the cost of homeowners insurance, home maintenance costs, perhaps the new furniture and appliances you will buy, to your preferred lifestyle (eating out, travel and so on) and potential lifestyle changes like having children or moving from a dual- to a single-income situation. And keep in mind that your mortgage interest rate could increase over time.
Once you’ve accurately established the real costs of your dream home, be sure you won’t end up ‘housebound’ with too much of your money going towards mortgage payments by:
• Creating a budget and trying it out for a few months to see if it’s doable.
• Considering a smaller house and mortgage that gives you more lifestyle and spending flexibility.
• Working with your professional advisor and a mortgage planning specialist to incorporate housing costs into your overall long-term financial plan – and to determine which mortgage options and payments work best for you.
Finding the right home is a terrific accomplishment – and with the right financial plan, you can feel perfectly comfortable in it and accomplish all your other life goals.
This column, written and published by Investors Group Financial Services Inc. (in Québec – a Financial Services Firm), and Investors Group Securities Inc. (in Québec, a firm in Financial Planning) presents general information only and is not a solicitation to buy or sell any investments. Contact your own advisor for specific advice about your circumstances. For more information on this topic please contact your Investors Group Consultant.