Are you Financially Ready?
So, you've decided that homeownership is right for you. Now you need to determine if you are financially ready to buy a house.
You will find a number of simple calculations that you can do to evaluate your current financial situation, how much house you can afford and the maximum home price that you should be considering.
Once you understand these variables, you can make the best choice for you and even save money.
Knowing your net worth is important because you will need this information when you discuss a mortgage with your lender. Your net worth is the amount left over once you've subtracted your total liabilities from your total assets. It will also give you a snapshot of your current financial situation and show you how much you can afford to put as a down payment.
How Much Can You Afford?
Now that you have a clear picture of your current financial situation, it's time to find out what you can afford in monthly housing costs. Lenders follow two simple affordability rules to determine how much you can pay.
The first affordability rule is that your monthly housing costs shouldn't be more than 32% of your gross household monthly income. Housing costs include monthly mortgage principal and interest, taxes and heating expenses — known as P.I.T.H. for short. If applicable, this sum also includes half of monthly condominium fees and the entire annual site lease (in the case of leasehold tenure).
Lenders add up these housing costs to determine what percentage they are of your gross monthly income. This figure is known as your Gross Debt Service (GDS) ratio. Remember, it must be 32% or less. The second affordability rule is that your entire monthly debt load shouldn't be more than 40% of your gross monthly income. This includes housing costs and other debts, such as car loans and credit card payments. Lenders add up these debts to determine what percentage they are of your gross household monthly income. This figure is your Total Debt Service (TDS) ratio.
The maximum home price that you can afford depends on a number of factors but the most important are your gross household income, your down payment and the mortgage interest rate.
For most people the hardest part of buying a home – especially the first one – is saving the necessary down payment. Many people will not have 20% of the purchase price to put down. With mortgage loan insurance, you can purchase a home with little or no down payment. Mortgage loan insurance protects the lender and, by law, most Canadian lending institutions require it. The way it works is if the borrower defaults (fails to pay) on the mortgage, the lender is paid back by the insurer. The cost for this type of insurance is in the form of a premium and can be paid in a single lump sum or it can be added to your mortgage and included in your monthly payments.
For homebuyers who have saved up a down payment, most mortgage loan insurance products require homebuyers to provide the down payment from their own resources, such as savings and RRSPs. Gift down payments from immediate relatives are also acceptable.
Get a Mortgage Pre-Approval
Once you've made the necessary calculations and feel that you are ready to obtain a mortgage, it's a good idea to select a lender to get pre-approved. This means that the lender will look at your finances to establish the amount of mortgage you can afford. At that time, the lender will give you a written confirmation or certificate for a fixed interest rate good for a specific period of time.
Some buyers may not wish to pursue a mortgage pre-approval until they have found the home they want to buy. However, the idea of having a pre-approved mortgage amount makes the search for your new home much easier and less time-consuming because you have a good price range in mind. Also, you do not want to fall in love with something that you cannot have.
Some of the things you will need to have with you the first time you meet with a lender are:
- I can provide you recommendations. ( Contact me for a list )
- Your personal information, including identification such as your driver's license
- Details on your job, including confirmation of salary in the form of a letter from your employer
- Your sources of income
- Information and details on all bank accounts, loans and other debts
- Proof of financial assets
- Source and amount of down payment and deposit
- Proof of source of funds for the closing costs (these are usually between 1.5% and 4% of the purchase price)
Will You Have Trouble Qualifying for a Mortgage?
Here are some things you can do:
- Pay off some loans first
- Save for a larger down payment
- Revise your target house price
- Other Helpful Strategies
- Meet with a credit counsellor who can help you minimize your debts.
- Buy your home through a rent-to-own program provided by the builder, a non-profit sponsor or a government sponsor.
- Find out about programs through which you can help build your own home.
- Ask the housing department of your municipality about any special programs available.
