Know Yourself - How Much Can You Afford?

Before you start shopping for a house, and for a mortgage, it is important for you to determine how much you can afford.

Pre-approval

The easiest way to find out is to ask for a "pre-approval" from a financial institution. To do this, you submit your financial information to a potential lender, which approves you for a predetermined mortgage amount. The pre-approval agreement, which normally does not involve any obligation on your part (you are not signing a mortgage contract), may also guarantee the interest rate for a mortgage taken out during the 60- to 120-day pre-approval period.

Look at your financial situation

Although you may find the financial institution's pre-approval convenient, remember that the pre-approved loan represents the maximum amount you could pay for a house, according to the lender's criteria and the information you have provided. However, it may overestimate what you can actually afford, since it does not take into account the extra costs associated with purchasing a house (for example, the unexpected expenses you may incur from time to time, changes in interest rates that might substantially increase your housing costs, and any other future financial obligations such as the replacement of a car). It is therefore important that you fully understand what your financial situation is and your financial plan to handle future payments.

Before you start shopping for a house, keep track of your monthly income and expenses to determine how long your need to save to accumulate the required down payment to purchase the house that you have chosen, and whether you can afford the monthly mortgage payments.

As a rule of thumb, your maximum monthly housing costs should not exceed 32 per cent of your gross monthly income, and your monthly debt payments should not exceed 40 per cent of your gross monthly income.

In fact, your ratios should be lower than the maximum outlined above, to give you flexibility in case of unexpected expenses, or changes in your mortgage conditions (e.g., a sharp increase in the interest rate when you renew your mortgage).

Extra costs

Remember that there is more to buying a home than paying the down payment and mortgage. You'll need to budget another 1.5 to 4 per cent of the price of your home to cover extra costs such as legal fees, land transfer tax and tax adjustments.

Find out more about the New Concept Mortgages.

Source: FCAC
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