When you purchase a home, there are many costs that must be accounted for besides your mortgage. You want to ensure that you don’t fall into the trap of being house-rich but cash poor.
The Golden Rule 30%
In the past, the Golden Rule for mortgage affordability has been 28-30% of your gross income.
Example: If your gross pay is $80,000, you would multiply that by 0.3 and divide by 12.
(80,000*0.3)/12=$2,000.
You may find lenders willing to work with you at lower rates, but being able to buy a home and being able to afford a home can be two different things. In June 2021, the stress test for affordability of a mortgage changed to 5.25% OR your actual mortgage rate plus 2.0%. This means that if you have a variable rate of 6.25% (December 2022), you will need to be able to afford your mortgage at an interest rate of 8.25%.
In these economic conditions with a rising rate environment, the previous ‘Golden Rule’ of 28% should be considered to be the low end of what you will need to cover the cost of home ownership.
First-Time Home Buyers Beware
If you’re purchasing your first home, beware that the amount a mortgage lender may give you might be more than you can afford. This is especially true if you are purchasing an older home or one that might need repair.
Quick Take:
- Home purchases have hidden and obvious costs that may increase your monthly payments.
- Before purchasing a home, you should also calculate your entire debt to income ratio. If you need to service debt or have additional monthly costs, it will lower the amount of home that you can afford.
- CMHC allows for a minimum down payment of 5% on homes that cost less than $500,000. If a home costs more than $500,000 than the down payment will need to be 10% for the amount over $500,000. If a home costs more than $1,000,000 than a 20% down payment is necessary for the value of the home.
- A down payment of over 20% means that you may not need to pay for mortgage insurance which will lower your costs in the long run.
A Large Down Payment Can Increase the Amount of Home You Can Afford
With a 20% down payment, you can usually avoid paying for mortgage insurance saving you on the cost of CMHC mortgage loan insurance. A large down payment can also reduce your monthly fees. Depending on the economic environment it may be beneficial to put more money down and reduce your payment instead of putting that money in a higher-risk investment. It all depends on your risk appetite.
Other Expenses for Owning a Home
While a mortgage may be the largest payment that is required of a home, there are also many other things to consider.
Repairs: Typically you should expect to pay 1% of the total cost of your home per year on repairs/maintenance of your home. While this guideline is a great estimate for the general costs that you should be putting aside, it doesn’t take into account that sometimes, when you own a home – things just break. For example, an unexpected furnace failure or a damaged roof may set you back thousands of dollars within the first year of home ownership.
Utilities: While these costs can change throughout the year, they are typically fairly consistent yearly, depending on the home. If you’re purchasing an older home, you may want to look at the winter utility bills to ensure that it is adequately insulated.
Lawn/Snow/Garden: While much of this maintenance can be done yourself, many homeowners opt to use a service to take care of the exterior of their homes. If you plan on using one of these services, you will need to take that into account.
Related:
Seven Tips to Start Your Home Buying Search
What are the Most Common Mistakes that Homebuyers Make in Alberta