What Can You Afford?
Before you start looking for a new home, it is important that you become aware of how much you can afford to pay. This knowledge will allow you to spend your valuable time looking productively at homes which are within your predetermined price range. You can calculate a relatively accurate figure for yourself if you assemble the following information:
$ _____ The cash you have saved to be used for this home purchase is called the down-payment.
$ _____ Plus: The amount of borrowed money you are able to arrange.
$ _____ Less: Closing costs and other “last minute” costs associate with the real estate purchase.
$ _____ Equals: Maximum Price
Lending institutions will usually require you to make a down-payment of at least 5% to 10% of the purchase price of the home. Lending institution policies may vary from time to time. However, as a general rule, you should make your cash down-payment as large as possible. Your deposit for the real estate transaction may form part of your down-payment.
The Borrowed Money
Almost everyone who purchases a home borrows some of the money needed to pay for it. The easiest way to determine how much money you will be able to borrow as a mortgage loan is to consult with one or more lending institutions. These lenders will apply standard tests, based on your family’s current income and debts, in order to decide the amount of money they will lend to you. They will ask for information about your finances and make a thorough credit check, in order to be sure you are able to repay a loan.
What is a Mortgage?
Obtaining a loan to finance the purchase of your new home will probably require you to sign a document called a mortgage. This document will set out the terms and conditions for the loan and its repayment. If you fail to meet your debt obligations, the lender may have the right to claim your home to pay off what you still owe.
What Types of Mortgage Loans Are There?
All mortgage loans are of two basic types:
A conventional mortgage loan allows borrowing up to 75% of the purchase price or the appraised value of the home, whichever is less. A high-ratio mortgage loan allows borrowing more than 75% of the purchase price or the appraised value of the home, whichever is less. But the borrower must pay a mortgage default insurance premium to protect the lender if payments are not made. Check with your lender to find out the amount of the insurance premium.
What is an Amortization Period?
Typically, the size of a mortgage loan payment is calculated as if the loan payments were going to be paid over 20 or 25 years. This is called the amortization period. Each payment will repay the interest due up to the payment date along with some of the principal owed. The longer the amortization period you choose, the lower the regular payment will be. Keep in mind that the faster you repay any money borrowed by choosing a shorter amortization period, the more you reduce the total cost of borrowing.
What is a Term?
Most mortgage loan contracts only permit the regular payments to continue for a specified term which is shorter than the amortization period. The term can be as short as six months or it can be five years or more.
At the end of the term, you are required to repay the full unpaid balance. If you don’t have the cash required to pay the balance, it may be necessary to refinance the loan.
Deciding on the length of term you want will depend partly on whether you think interest rates will go up or down. Keep in mind that the longer the term you choose, the longer your monthly payment remains stable.
CAUTION: The lender is not obligated to renew your mortgage loan at the end of the term.
How Much Can You Afford to Pay in Mortgage Payments?
Based on Your Income:
A general guideline is to allow no more than 30% of your gross monthly income (before deductions) to make your monthly housing payments. This test of your ability to repay a mortgage loan is generally referred to as the Gross Debt Service Ratio.
Complete the following calculation to determine the approximate amount you may be able to afford for the mortgage payment, the property taxes and, where applicable, 50% of the strata maintenance fees. Some lenders will require that this total maximum monthly payment also covers heating costs.
- Your gross monthly income $___
- Co-signor’s gross monthly income (if applicable) $_____
- Other income (monthly) $______
- Total monthly income $______
- Multiply the Total line above by 30% to calculate your: Total monthly maximum housing payment $______
Based on your Other Financial Obligations:
If you have other monthly financial obligations, such as car or credit card payments, the lending institution will also apply the Total Debt Service Ratio test to determine the maximum mortgage loan for which you can qualify.
$ ____ Your monthly housing payment
$ ____ Your calculated monthly debt payments (car, credit card, etc.)
$ ____ Total monthly payment
A general guideline should be that the total of your monthly housing payment added to your other monthly debt payments should not exceed 40% of your monthly gross income.
The Gross Debt Service Ratio and the Total Debt Service Ratio tests protect both you and the lender by ensuring that you do not take on more debt that you can reasonably afford to repay.
Many lending institutions will prequalify you for a specific size and type of mortgage loan before you begin searching for your new home. Taking the time to apply for a pre-approved mortgage will give you the security of knowing how much you can afford to spend.
Before concluding the loan agreement, most lending institutions will require an appraisal of your selected home. The appraised value is a professional opinion of the value of the home and may differ from the purchase price you are willing to pay. The appraised value may affect the approved value of the loan.
The Closing Costs
It’s easy to count your available cash, but remember that all of these cash savings cannot be used as your down-payment. There are last-minute costs, such as taxes, legal fees, appraisal fees, moving expenses, and home insurance to pay before you are finally in your new home. The time to budget for those “end” expenses is now. You must be prepared to pay most, and perhaps all, of the following closing costs.
Property Transfer Tax – The British Columbia Provincial Government imposes a property transfer tax, which must be paid before any home can be legally transferred to a new owner. Some buyers may be exempt from this tax. For further information, please view the Property Transfer Tax office website at www.sbr.gov.bc.ca/business/Property_Taxes/Property_Transfer_Tax/ptt.htm.
Goods & Services Tax – If you purchase a newly constructed home, you may be subject to GST on the purchase price. There may be some rebates available depending on the value of the home. For further information, contact the Canada Revenue Agency at www.cra-arc.gc.ca.
Property Tax – If the current owners have already paid the full year’s property taxes to the municipality, you will have to reimburse them for your share of the year’s taxes.
Appraisal Fee – When the lending institution requires an appraisal of the home before approving your loan, it may be your responsibility to pay the appraiser’s fee.
Survey Fee – The lending institution may also require that a survey certificate be presented to them. The purpose of the survey is to formally establish the boundaries of the property and to ensure that all buildings are within those boundaries.
Note: Lending institutions may ask for either a building location survey, which establishes where a building is located on a property, or a monumental survey, which establishes the actual boundaries of a property. If the current owner cannot provide a recent survey certificate, it will be your responsibility to pay the surveyor’s fee.
Mortgage Application Fee – Lending institutions may charge a mortgage application fee. This application fee may vary between lending institutions.
Don’t forget about last minute costs
Mortgage Default Insurance – This type of insurance is required on most mortgage loans in excess of 75% of the appraised home value. Its purpose is to ensure that the lender will not lose any money if you cannot make your mortgage payments and the value of your home is not sufficient to repay your mortgage debt. The insurance premium is paid to the lender and, in most cases, is added to the loan amount and paid for over the term of the
Life & Disability Mortgage Insurance – At your option, you may purchase insurance which will ensure that your outstanding mortgage balance is paid if you die or become disabled.
Fire & Liability Insurance – The mortgage lender will insist that you purchase an insurance policy which guarantees that, in the event of fire, the lender will receive the balance owing on the mortgage loan before you receive any insurance proceeds.
Legal Fees – The transfer of home ownership from the seller to the buyer must be recorded in the Land Title and Survey Authority Office in order to protect the new owner’s interests.
You will probably want to engage a lawyer or notary public to act on your behalf during the completion of your purchase. The lawyer or notary public will charge a fee for this service, plus disbursements, including the Land Title Registration fee. If you are financing your purchase with a new mortgage loan, there will be a further fee and disbursements to prepare and register the mortgage documents.
Other last-minute costs you shouldn’t forget to set some money aside for:
- home inspection fees
- moving expenses
- deposits required by utility companies
- household goods:
- kitchen appliances,
- garden equipment,
- garbage cans, tools, window coverings, etc.
- redecorating or renovations
- Publication "What can you Afford?"
original author and publication by RECBC