Spring House Buying…What Can You Afford?

Spring House Buying…What Can You Afford?

Q. Our combined household annual income is $120,000. With overtime work, I earn an additional $40,000 each year. My wife and I would like to buy a larger house worth about $350,000 and we will have a down payment of $85,000 with the sale of our condo. Housing prices in our area are booming and we want to jump in before they get out of reach for us. I am concerned, however, as my overtime work is not guaranteed. Does this make sense for us? – Don S.

A. There are two major considerations here, the amount of household debt you can reasonably assume and the type of mortgage you could get based on your proposed down payment.

Most financial institutions use two parameters in determining how much you can afford to borrow: Gross Debt Service Ratio (GDSR) and Total Debt Service Ratio (TDSR). The GDSR is the percentage of your combined gross annual income required to cover payments associated with housing including mortgage, principal, interest, taxes, secondary financing, heating, and 50% of condo fees if any. GDSR should not exceed 32% of gross annual income. The TDSR is the percentage of gross annual income required to cover payments associated with housing and all other debts and obligations such as car loans and credit cards. The TDSR should not normally exceed 40% of your gross income. When determining what works best for your situation, you are prudent to consider only your guaranteed cash flow and ability to manage payments.

Second, the amount that you’re able to put towards your down payment will determine whether you will qualify for a conventional or high-ratio mortgage. Where the mortgage exceeds 75% of the purchase price of the property, which is the case for you ($85/$350 = 24%), it must be insured. Both Canada Mortgage and Housing Corporation (CMHC) and Genworth Financial Canada provide mortgage default insurance to lenders. An insured or high-ratio mortgage will increase your costs since there are application fees and an insurance premium which may be added to your mortgage.

Household debt as a percentage of disposable income has been rising in Canada, although this has been manageable in the current environment of low interest rates and rising incomes. With the prospect of rising interest rates, homebuyers should exercise some caution, especially if they don’t expect a commensurate rise in income. That being said, home ownership debt is often considered ‘good’ debt, as it forces savings and builds equity in an appreciable asset – a home. Since you will need a place to live for as long as you are alive, homeownership is a worthwhile goal. Next week I will address questions about mortgage protection.

Bev Moir is a financial planner with The Moir Team at ScotiaMcLeod in Toronto. ScotiaMcLeod is a division of Scotia Capital Inc., a member of the Scotiabank Group. Member CIPF.

This article is for information purposes only. It is recommended that individuals consult with a financial or tax advisor before acting on any information contained in this article. The opinions stated are not necessarily those of Scotia Capital or The Bank of Nova Scotia.