A single mom wrote to me recently asking for some advice about buying a home. She wants to know how much she should put down, and how much she can reasonably afford to spend. While she’s been pre-approved for a mortgage – a good first step – she’s uncomfortable with the amount the lender seems willing to give her and wants to know what’s realistic.

Lenders use a calculation called debt service ratio to calculate how much they’ll lend you based on how much you can afford to repay each month. Gross Debt Service Ratio is the percentage of your gross annual income that it takes to cover payments associated with keeping a roof over your head: mortgage payments, property tax, heating, condo fees. Total Debt Service Ratio also takes into account other debt you may have like a car loan or lease and outstanding balances/limits on credit cards. Every lender has a limit for how much GDSR or TDSR is acceptable, generally been 32% and 40% respectively. However, for folks with very high credit scores, GDS requirements are often waived and the TDS maximum is often higher. This can get responsible borrowers into trouble because it means they can end up over-extending themselves.

Let’s use the gross debt service ratio of 32% as a starting point to determine how much you can afford. If you make \$5,000 a month before taxes, 32% of that would be \$1,600 a month, which is what the bank will say you can afford in mortgage payments. With an interest rate of 6%, amortized for 25 years, you could afford a mortgage of about \$190,000. Add on your downpayment and violá, you’ve got the amount of house you can afford.

Now I say all this as a guide. And it’s a good guide. But since people are getting into houses today, who would never have qualified to buy five years ago, before you jump into the fray, you need to know the facts.

Let’s work with the following. Let’s assume you’re planning to take on a \$250,000 mortgage and that current interest rates for a 5-year term are 5.34%.

First let’s look at how amortization affects your repayment of principal and interest costs over the five-year term.

Amortization           Monthly Payment            Principal Pd              Interest Pd

15                           \$2,014                              \$62,589                     \$58,241

20                           \$1,689                              \$40,337                     \$61,004

25                           \$1,503                              \$27,579                     \$62,588

30                           \$1,385                              \$19,538                     \$63,586

The shorter your amortization, the higher your monthly payment and the faster your pay your mortgage off. Going from a 15-year to a 30-year amortization means you’ll pay off two-thirds LESS on your principal over that five-year term. So, over the life of the mortgage you’ll pay a whack-load more in interest. But you’ll have a lower monthly payment to deal with.

Now let’s turn to downpayment. If you buy a home with anything less than 20% down, you’re going to have to buy high-ratio mortgage insurance. This insurance premium is calculated as a percentage of the loan amount, and the percentage depends on the loan to value ratio. The higher the loan to value ratio – the amount your borrowing relative to the value of the home — the higher the premium cost. So the lower your downpayment the more expensive the insurance. How expensive?

If you put 15% down, your mortgage insurance premium will be 1.75% of the mortgage, or \$4,375 on your \$250,000 mortgage. But if you only put 5% down, your premium will be 2.75% or \$6,875. This premium may be paid in cash (nobody does this) or added to the mortgage amount (making your mortgage even larger).

Ultimately, the amount of home you can afford to buy depends on how much you’re spending elsewhere in your life. If you have no student or consumer debt you can spend anywhere from 35-50% of your take-home pay on your shelter costs, assuming all your other costs are in line. Shelter costs include your mortgage payment, property taxes, insurance, utilities and maintenance. Your other costs include transportation: 15%, saving 10%, life (including things like food, daycare costs, and clothes) 25%.

Before you jump up and down clicking your heels together at how much mortgage you’ve been approved for, do the math for yourself: add up all your costs and figure out just how much YOU can actually afford to commit to a mortgage payment.

I’m not trying to scare y’all away from home ownership. I’m trying to impress upon you that home ownership is a BIG responsibility, not one to be taken on lightly. And I’m trying to show you that spending a little time saving for a downpayment makes way more sense than locking yourself into a mortgage payment that strangles your cash flow while paying exorbitant amounts in interest and insurance premiums.

### 9 Responses to “Buying a Home”

1. Thank you for being the voice in my head and for having coffee with me weekday mornings.

March 28, 2016 at 7:07 pm

We knew that a shorter amortization would decrease the interest, but we went for the long amortization. Our required payment is “low”, but we always double up, and also make a prepayment every year. This way, if the caca hits the fan, we can always cut out or reduce the double up and our prepayment. We probably would have been fine with the short amortization, but having that little bit of wiggle room brought me peace of mind. Two years in, and we’ve already saved more than half the interest that we were supposed to pay.

We did the same. We took out 30 year loan, but have increased our mortgage payment to bi-weekly and also increase our prepayment. Our mortgage with Scotia “allows” us up to 20% of prepayment per year. It has no limit of the number of prepayment that you can make a year. So I write an extra prepayment cheque biweekly, based on our budget for that month. This goes straight to our principal. This way if our income hits a rough patch or a large emergency happens, we still can pay for our regular mortgage. We have had to deal with losing both our jobs within a few weeks of each other, having 2 babies 12 months apart (surprise!), only 1 income for 3 years, paying for a full time daycare spot to hold it for a year without actually using it (daycare here has a 4 year wait list), etc. Life throws you lots of curve balls, having a bit of a wiggle room sure helps us breath and sleep better.

If we keep on track, we should have this mortgage taken care of in 12 years. We did the same with our previous mortgage and was able to clear it in 7 years, then took the equity of the house to move up to a bigger house for our growing family.

I think this only works if you have the discipline for it.

4. We were approved for \$400,000 and laughed as we only made \$90,000 a year and knew we couldn’t afford that. We took \$172,000 and still found the first 3 years of home ownership a challenge with higher than expected costs. It is NOT the same as renting people! Our income has gone up since significantly so we do biweekly payments that are higher than the minimum and also prepayments. Not quite 4 years in and down to less than 15 amortization remaining.

5. Don’t forget all the associated costs of home ownership…maintenance, taxes, utilities all take a whack of cash over and above your mortgage. Those people going from an all-in rent charge definitely have to factor in all the extra costs. They add up fast!

6. re my last comment…I didn’t read well enough I guess as Gail covered it a bit….”Gross Debt Service Ratio is the percentage of your gross annual income that it takes to cover payments associated with keeping a roof over your head: mortgage payments, property tax, heating, condo fees” but then wrote “However, for folks with very high credit scores, GDS requirements are often waived and the TDS maximum is often higher. This can get responsible borrowers into trouble because it means they can end up over-extending themselves.”

When I was trying to figure out how much I could afford to spend monthly for a place to live, all in (taxes, maintenance fees, mortgage), I added up everything I was already paying for (or had a line item in my budget), less the rent (groceries, gas, car maintenance savings, travel savings, retirement, emergency fund, car insurance, tenants insurance etc etc AND etc!). Whatever was left was the ABSOLUTE maximum that I decided I would be able to spend and I spent a little less, and I don’t have to worry about money a whole lot.

7. After having read and listened to Gail for years, I am proof that it can be done.

I am a single mom by choice of a 3 year old and I just bought my first house. I chose to move out of Toronto, to make it happen and transferred my job to Waterloo.

I paid \$327,000.00 for my house and I put 20% down. I also saved up the closing costs so that those will be paid in cash. (Closing in June 2016).

My mortgage is 2.25% variable for 5 years and I have chosen biweekly payments over a 25 year amortisation period. My mortgage will cost me \$1140 a month. Utilities and Property Taxes on top of course. I currently pay \$1170 in rent plus utilities for a similar sized townhouse.

I am also currently socking away over \$1000.00 in savings divided up into an emergency fund, RESP for my daughter, RRSP for me and a Pension for work.

I don’t make a ton of money \$71K gross a year, and I have no debt.

I just wanted to post this to show people that it is possible to own a house and be on your own and still live within a person’s means.