Whether you are a first time home buyer or looking at purchasing a new home, it is essential to understand what you can afford. You don’t want to have your realtor showing you houses that there is no chance of you purchasing or on the other hand showing you houses that you do not really like but think that is all you can afford. When determining how much you can afford, lenders look at two factors: down payment and debt service ratios. Debt service ratios broken down are income compared to debt. I will break down the two debt service ratios – Gross Debt Service Ratio and Total Debt Service Ratio later in this blog.
In Canada, there is a minimum requirement of 5% for down payment. In other words you must have access to a minimum of 5% of the purchase price of the home. For example if the purchase price of the home is $300,000 you need to have $15,000 for the down payment. The other factor that comes into play when discussing down payment is that if you have a down payment of less than 20% you will be subject to mortgage default insurance which protects the lender if you default on payments. This premium will be added to your regular mortgage payments. One other factor to keep in mind is that if the purchase price of the home is higher than $500,000, the minimum down payment is 5% on the first $500,000 and 10% after that. If the purchase price is $1,000,000 or more a minimum of 20% down is required.
As mentioned above, there are two debt service ratios that lenders look at when deciding on the maximum mortgage you can receive. Your Gross Debt Service Ratio (GDS) is your mortgage payment, property taxes, heating cost, and half of condo fees (if applicable) divided by your income. Your Total Debt Service Ratio (TDS) is the expenses included in the GDS plus any other regular payments such as car loans, credit card debt, or loan expenses divided but your income. The maximum GDS that most A lenders will accept is 39% and TDS is 44%. As you can see above, you must be aware of your debt load when you are considering purchasing a home.
It is important to keep in mind that you will need 1.5% of the purchase price of the home for closing costs. These closing costs include legal fees, land transfer tax, and title insurance.
There are three solutions to increasing your maximum mortgage affordability depending on what the issue is: You can save money and temporarily delay purchasing a home in order to increase your down payment. If it is the debt service ratios that are presenting an issue, you can either find a way to increase your income or pay off some of your debt.