Buying a home is a big deal. It is a long commitment (think 25 years) and a lot of debt. It’s certainly nothing to sneeze at. If you’ve hashed out the rent versus buy debate and have decided that for you, buying is what you want, you’ll want to think about how much home you can actually afford before you go home-hunting.
These days, the big banks are pretty uptight about loaning Average Joe money and will scrutinize your application much more than in the past. The Canadian banks are trying not to let a housing crisis occur (though some may beg to differ that nothing can stop this tsunami) and therefore are more evaluative in terms of loaning you money.
Thinking about the criteria to determine how much home you can afford from a bank’s perspective and from your own perspective is important before you take that plunge and make an offer.
The Banks Approach
In order to see how much money they should loan you (and to make sure you’re not just shooting the breeze when you say you made $75,000 last year), the banks will ask for your:
- Recent pay stub
- Recent bank statement
- Recent investment statements
- Latest T4
They use this information to see if you are a good candidate to lend money to. The banks typically do not loan you money that is more than 32% of your gross income should go to mortgage expenses. Though they would likely lend you more than the Housing Affordability Index would recommend. After tax, that translates to even less dedicated to shelter expenses, which are mortgage, property taxes, utility bills, and maintenance fees, if applicable.
When you think about affordability, you need to also think about whether you will choose a fixed or a variable rate, and how many years of amortization you are going to opt for. Differences in these can affect your cash flow and how much home you can afford.
Your Approach
Obviously, the bank will pre-approve you for more money than you should really borrow. They are in the business to make money (mortgage interest) off you. Be wary of only borrowing how much you can really afford.
It also is different for everyone. Some people like to have a bit more risk than others, and will be more comfortable with more debt for potentially more gain (e.g. buying a home versus a condo). Others are happier with less risk and more diversification outside of real estate, like buying equities and ETFs.
Related: Check Out Our Book on ETF Investing
According to The Canada Housing Mortgage Corporation, a good rule of thumb is to multiple the amount of home that you can afford from your total income by three times. The total debt payments should be no more than 40% of gross income. In addition, drafting up a budget that includes your total home payments and all the other monthly expenses (savings, groceries, entertainment, utilities) is also helpful to assist in gauging how much home can be affordable. If you are not a paycheque to paycheque type of person, you will greatly benefit from knowing in advance just how much it is going to cost to own that home you just developed emotional attachment to.
Another thing to think about before you buy that home are the costs of buying and selling your home. If you are a first time home buyer and are buying a home that costs less than $450,000 in B.C., you are entitled to a waiver of the property transfer tax, which can cost approximately $5000 on a $350,000 home. Also, think about the realtor costs when you eventually sell the home (depending on what your timeline is) and the GST on the home if applicable. The realtor costs can be quite expensive, as it is usually 3.5% on the first $100,000 and 2.25% on the balance.
Related: House Hunting Tips – Dual Agency Realtor
As we all know, the pride of home ownership comes at a steep cost. If the cost of home ownership is overwhelming for you (if that variable rate will keep you up at night), you may want to reconsider the rent versus buy debate and rent instead of buy.