Mortgage affordability in Canada
Answering the question “How much house can I afford?” ultimately depends on the mortgage amount you can get approved for. When determining that figure, lenders consider more than just your income and the price of the home you’d like to buy.
Factors that affect affordability
The amount a lender decides to loan you depends on other important numbers: your down payment amount, debt service ratios and the minimum qualifying rate — also known as the mortgage stress test.
Down payment amount
In Canada, you’re required to have a minimum down payment of at least 5% of the purchase price when buying a home. But that’s only for homes valued at $500,000 or less.
For homes worth between $500,000 and $999,999, you’ll have to put 5% down on the amount up to $500,000 and 10% on the amount over $500,000. Homes worth $1 million or more require a down payment of at least 20%.
| Purchase price | Minimum down payment required |
|---|---|
| Less than $500,000 | 5% of the purchase price |
| $500,000 to $999,999 | 5% of the purchase price for the first $500,000; 10% for the portion above $500,000 |
| $1 million or more | 20% of the purchase price |
Remember that providing only a minimum down payment could mean paying a higher mortgage rate. Depending on the price of the home, your income and the overall state of your finances, you may be required to put down significantly more than 5% payment to qualify for a mortgage on the house you want.
Conversely, putting down a larger down payment can help you borrow less and qualify for a lower rate.
Gross debt service and total debt service ratios
Lenders look at two major factors, your gross debt service (GDS) and total debt service (TDS) ratios, when deciding how much they’re willing to loan you.
Your GDS is calculated based on how much your housing expenses are relative to your pre-tax income. These expenses would include your mortgage, property taxes, heat and any maintenance fees for condominiums. Lenders don’t want this ratio to exceed 39% of your gross (pre-tax) income.
When it comes to your TDS, take your GDS and add any other outstanding debt payments that you currently have, such as student loans and credit card debt. Your TDS shouldn’t exceed 44% of your gross income.
When buying with a partner, lenders will look at your combined ratios as opposed to individually. What that means is that even if one of the purchasers has a GDS or TDS that exceeds the limit, you may still qualify for a mortgage as a couple.
The mortgage stress test
Anyone applying for a new mortgage or renewing their current loan with a new lender will need to pass the mortgage stress test.
With the government stress test, it’s not enough that you qualify at your lender’s offered rate. You must be able to qualify at the higher of:
- A rate of 5.25%.
- The interest rate offered by your lender plus 2%.
So if a lender offers you a mortgage of 5% for five years, you actually need to qualify at 7%. This calculation is meant to protect you if interest rates rise, but it does lower the total amount you can borrow.
Other mortgage affordability factors
While the above factors formally determine how much money you can borrow, they may not actually translate to what you can afford. It’s essential to think about each of the following before you make a purchase:
- Closing costs. Generally speaking, you should set aside 1.5% to 4% of a home’s purchase price to cover closing costs, which include things such as legal and land transfer fees.
- Mortgage insurance costs. If your down payment is worth less than 20% of your home’s sale price, you will be required to buy mortgage default insurance. Mortgage insurance premiums range from 0.60% to 4.50% of your mortgage loan amount, and can be paid upfront or as part of your monthly mortgage payment.
- Maintenance fees. If you buy a condo or townhouse, you may have to pay a maintenance fee every month you own your property. Lenders factor some of these costs into their underwriting.
- Property taxes and utilities. These annual and monthly costs also need to be accounted for.
- Commuting costs. If you choose to buy a house in a community away from the one you work in, you need to factor in the cost of getting to your job. Will you be filling up your gas tank an extra time or two a week? Will you be taking public transit? These costs can really add up.
- Moving costs. You might need to pay movers when you buy, and you may need to buy furniture.
- Personal goals. Affordability calculators don’t consider your personal goals, such as retirement plans, vacations or the cost of raising kids.
- Budgeting. Lenders use pre-tax dollars as a simple way to calculate affordability, but it might be wise to use after-tax dollars when budgeting your mortgage payment, since that’s how much money you’ll have each month.
Because other expenses will inevitably come up while you own your home, you may not want to borrow the maximum amount a lender offers you. When determining your overall budget, consider using after-tax dollars to give you a more realistic idea of how much money you’ll have access to each month.
How to improve mortgage affordability
To qualify for a mortgage that’s both large enough to buy the home you want and offered at an interest rate you can afford, you’ll have to convince lenders that you pose low risk as a borrower. Following these four steps can help you do that.
1. Have a steady, healthy income
Lenders need to see evidence that your income is both stable and sufficient enough to cover the cost of a mortgage. You can show proof of income using a letter of employment from your company and recent paystubs.
Not all income will be equal in a lender’s eyes. It can be easier to apply when you have a salaried position as opposed to a self-employed income stream. Similarly, the longer you’ve been employed the better. Ideally, you will have at least two years of stable work history at the same company to prove your income.
The more you earn, the less risky you’ll appear to lenders — and the more they’re likely to loan you.
2. Have a strong credit score and credit history
Your credit score and credit history play a huge role in qualifying for a mortgage. A high credit score proves to lenders that you can reliably take on debt and pay it off consistently
A high credit score also helps you qualify for the best mortgage rates. That’s why it’s advisable to take a peak at your credit score before reaching out to lenders and determine if you should try to improve it. Searching for a mortgage with a credit score below 600 could mean dealing with alternative or private lenders who typically charge far higher interest rates than chartered banks or large B lenders.
3. Juice your down payment savings
In Canada, down payments can be a minimum of 5% for homes under $500,000, but a 5% down payment doesn’t guarantee that you’ll be approved for a mortgage that works for you. Depending on your credit history, income and overall debt load, securing a lower rate and better loan terms may require putting down more than the minimum.
And if all those indicators are flashing green, saving up a larger down payment will make you look like even less of a risk. Lenders may see you as someone who establishes financial priorities and understands how to save.
Paying off more of your home up front is just good strategy, too. You’ll pay less in interest, and if the market goes sideways or some other event causes you to sell earlier than you anticipated,, you’ll have more equity to lean on.
4. Pay down your debt
Along with saving a larger down payment, chiseling away at debt is another area home buyers can struggle with. But coming to a lender with manageable debt service ratios can help you get offered a lower interest rate and secure a more affordable mortgage.
The two debt service ratios lenders consider when determining your mortgage rate are total debt service (TDS) and gross debt service (GDS) ratio. In order to qualify for a mortgage, your GDS should be lower than 39% of your pre-tax income and your TDS be under 44%.
Maintaining those levels won’t necessarily be easy for people with large credit card or credit line balances. If you can zero out some of these balances, it could be worth the sacrifice once it’s time for a lender to look at your finances.
Just don’t rush to close a credit product once you pay it off. Your credit utilization ratio, which indicates how much of your total available credit you’re using, also plays a part in the mortgage underwriting process. Keeping open seldomly-used credit products, or increasing a credit limit you have no intention of using, can help swing your credit utilization ratio in the right direction.
Mortgage affordability examples
Here are two simple scenarios that can help you understand how the various factors we discussed above can impact how much mortgage you can afford.
Scenario 1:
You have a monthly income of $5,000 and $50,000 in down payment savings. You want to buy a house that costs $250,000. To determine how much mortgage you might qualify for, lenders would consider financial obligations such as:
- Estimated heating costs: $150/month.
- Estimated property taxes: $200/month.
- Monthly credit card payments $100/month.
- Monthly car payment: $350/month.
In this simplified scenario, you will likely be able to afford this home. You should qualify for the needed mortgage amount of $200,000.00, since your GDS ratio (30.84%) does not exceed 39% and your TDS ratio (39.84%) does not exceed 44%.
Scenario 2:
You have a monthly income of $5,000, with $35,000 in down payment savings. The home you want to buy costs $350,000. Your financial obligations are the same as in Scenario 1.
In this simplified scenario, you’ll likely be denied the necessary mortgage amount of $324,765 ($315,000.00 + $9,765.00 in mortgage insurance premiums because your down payment is less than 20%), because your GDS ratio (45.71%) exceeds 39% and your TDS ratio (54.71%) exceeds 44%.
Next steps: Mortgage pre-qualification and pre-approval
Mortgage affordability and mortgage payment calculators can give you a general idea of how much house you can afford, but you’ll have to reach out to a lender or mortgage broker to find out what dollar amount you’ll actually be working with.
It’s best to do this before you go house hunting. Finding a home and making an offer without knowing what your budget is could be disastrous if your bid is accepted but no lenders agree to fund your purchase. Unless you’ve added a financing condition to your offer, you’ll be on the hook for a home you can’t pay for.
That’s why mortgage pre-qualification and pre-approval exist.
Mortgage pre-qualification
Mortgage pre-qualification is a fairly casual process, often done online, that works an awful lot like a mortgage affordability calculator. You provide some general financial information and a lender tells you how much they might be willing to loan you without performing a hard credit check.
Because pre-qualification is simple and quick, the amount you’re pre-qualified for is intended as an estimate. It might be identical to the amount you ultimately get approved for, but there’s no guarantee. That’s what pre-approval is for.
Mortgage pre-approval
With a mortgage pre-approval, a lender will take a much closer look at your finances and provide an actual mortgage offer that will be in effect for up to 120 days.
With pre-approval, you’ll be asked to provide several documents, including banking and employment information, that your lender will then verify. You’ll also have to consent to a hard credit check so your credit score and credit history can be evaluated.
It’s a lot more work than a mortgage pre-qualification, but pre-approval is a necessary step in the home buying process. Once you’re pre-approved, you’ll be able to bid confidently on a home that you know you can afford.
Frequently asked questions about mortgage affordability
The size of the mortgage you get approved for is based on much more than income. It also depends heavily on the size of your down payment, your credit score and how much debt you’re carrying. A borrower earning $100,000 who has a 640 credit score, a $10,000 down payment and $15,000 in credit card debt, for example, would probably be approved for less than someone earning $100,000 who has a credit score of 740, access to a $75,000 down payment and no credit card debt.
One rule of thumb you can try to implement is to borrow less than the maximum mortgage amount offered by your lender. Doing so will decrease your buying power, but it will create a little breathing room in case your monthly budget gets thrown off-course by a financial emergency or rising interest rates.
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