How much mortgage can I afford?

But I couldn’t accept the idea of taking on a bigger mortgage than the one I already had. The deal is done, but looking back, I think the question that concerned me more was: Am I comfortable with the mortgage I need to buy my new digs?

Angela Calla is a mortgage broker based in Port Coquitlam, B.C., and the author of The Mortgage Code, which is a money-saving guide to moving up the property ladder (the stages of homeownership, from initially having a smaller, less expensive place to buying and selling your way into more expensive real estate). 

Whether you’re buying your first home, upsizing or buying a second property, she says assessing your affordability is the first step towards homeownership, and it requires more homework than a quick Google search. It’s only once you have developed a clear picture of your personal finances—hopefully with the guidance of a financial planner—that you can make an informed decision about the mortgage you can afford.

“It should be normal practice for people to review their budget, their financial products, their bank statements and think about what their goals are,” she adds. “The difference in people who are more financially successful is not in their actual income. It’s the people who commit the time to review their finances regularly.”

Watch: What is mortgage affordability?

How to calculate mortgage affordability

First, let’s define mortgage affordability. Though it’s sometimes used in reference to the cost of living in a particular city relative to the average income in that area, you should think about it as the amount a bank or financial institution will allow you to borrow based on your income, debt and living expenses.

Your mortgage affordability is based on:

• Your annual income before tax

• Your monthly debt payments, which includes credit cards, loans and car payments

• Housing costs such as property taxes, heat and half of your condo/HOA fees (if applicable). For the latter, only half the amount is used, because condo fees can cover things like property maintenance, insurance and some utilities, which are not used in debt-service calculations for other types of properties.

According to the Canadian Mortgage and Housing Corporation, a mortgage is affordable when your gross debt service (GDS) ratio—which accounts for your housing costs—doesn’t exceed 39%. To be considered affordable, your total debt service (TDS) ratio—which accounts for housing costs as well as other debt obligations—must not surpass 44%.

To calculate your gross debt service ratio: 

1. Add up your housing costs (i.e. your mortgage payments, property taxes, heating and, if applicable, half of your condo fees.
2. Divide them by your gross income, which is your total earnings before taxes and deductions. 
3. To obtain your GDS in the form of a percentage, multiply the result by 100.

Let’s say your household brings in a combined $130,000 per year, and you expect to pay $3,000 per month on the mortgage for your new single-family home, plus another $500 on property taxes and $150 on heating. In the eyes of lenders, you would have a GDS of 38%.

To calculate your total debt service ratio: 

1. Add up your housing costs (mortgage payments, property taxes, heating and, if applicable, half of your condo fees). Also include any other debt obligations, such credit card and line of credit payments (based on monthly payment amounts of no less than 3% of the outstanding balance), car payments, student loans and child or spousal support. 
2. Divide the total by your gross income, which is your total earnings before taxes and deductions. 
3. To obtain your TDS in the form of a percentage, multiply the result by 100. 

Now, on top of your housing costs listed above, let’s assume your non-housing related debts come in at $800 per month (for example, $600 on credit card and line of credit payments and $200 on your car loan). Your TDS ratio would fall within the limit, at 41%.

When it came to buying my own place, I was well within these numbers, but how much I could end up spending on a new mortgage still made me squeamish. Already in my 40s, shouldn’t I be paying off my mortgage instead of adding to it?

“That’s not reality,” says Calla. As difficult as it might be, she says it’s important to not compare yourself to others. Make the decisions that best suit your lifestyle and goals.

The math behind your down payment

In my case, I was selling my condo to finance the purchase of my new home, so I calculated how much I would have for a down payment based on an estimate of my current home’s value.

First, I tallied the costs associated with moving, including real estate agent commissions, legal fees, moving-day expenses, a home inspection and land transfer taxes (living in Toronto comes with paying double the land transfer tax you pay in other parts of Ontario). To calculate closing costs, the rule of thumb is to budget for 4% of your home’s purchase price. A $500,000 home, for instance, would require $20,000.

I decided not to touch my investments or savings to cover these costs, so I subtracted them from the potential profit of the sale. That left me with a down payment of over 20%, which means I didn’t have to pay mortgage default insurance. 

Let’s bring the math to life using the example of a 25-year mortgage for a $500,000 home, assuming a 5-year term and 3% fixed interest rate. 

Because I was able to make a larger down payment, I knew that would lower my monthly mortgage payments (assuming the same 25-year amortization) as well as the amount of interest I would pay over time. My own calculations suggested I would save at least $50,000 in interest.

The math behind your monthly mortgage payments 

Now that I knew how much I could afford, it was time to estimate my monthly mortgage payments. With that amount handy, I would have an informed picture of my cash flow and financial well-being while living in my new home.

Let’s keep with our previous example of a 25-year mortgage for a $500,000 home, offered on a 5-year term and 3% fixed interest rate, to illustrate how a larger down payment can save you money in the long run. You can also use a mortgage payment calculator to help you get started.  

While making a larger down payment is a better financial move, Calla believes that securing any mortgage is a smart decision, even when you can only afford to put 5% down. 

“With homeownership, over 50% of the payment goes directly into your equity, while with renting, 100% goes to someone else,” she says. “And the gift of today’s low-interest rates gives you the ability to invest in yourself at an unprecedented rate.”

Still, following years of soaring real estate prices, saving for that 5% down payment remains a major hurdle for most people. In some cases, it may make more financial sense to continue renting and not stretch yourself too far. And if buying isn’t immediately in the cards for you, there are other strategies you can use to ensure you stay on track with your financial goals.

The next step: Getting a mortgage pre-approval

Calla strongly recommends getting a mortgage pre-approval before officially putting in an offer. “It’s the only way to gain an understanding of the real risk you’re going to be absorbing and how it’s going to impact your financial future,” she says.

This part of the process finally made me comfortable with the idea of upsizing to a new mortgage. I was able to confirm my financial health with a tally of my assets, a value assigned to my current home, and an informed look at my debts versus my income, which was all necessary info requested by the lender. 

The good news is I was approved for a larger mortgage than I needed. And with that pre-approval handy, I was able to make a confident offer.

More on mortgages:

• What is a mortgage?
• Understanding mortgage affordability calculators
• Homebuyers: How large should your downpayment be?