Buying a House: Part I – Affordability

The first step in house buying is figuring out how much house can you afford. The calculation depends on your family income, borrowing costs, the size of the down payment and your monthly debt payments.

Affordability Rule 1

The first rule is that your monthly housing costs shouldn’t be more than 32% of your gross monthly income. Housing costs include your monthly mortgage payments (principal and interest), property taxes and heating expenses. This is known as PITH for short — Principal, Interest, Taxes and Heating ( if buying a condo, include half of the monthly condo fees)

Affordability Rule 2

The second rule is that your entire monthly debt load should not be more than 40% of your gross monthly income. Your entire monthly debt load includes your housing costs (PITH) plus all your other debt payments (car loans or leases, credit card payments, lines of credit payments, student loans etc.). You have calculated these on the Monthly Debt Payments form. This figure is called your Total Debt Service (TDS) ratio.

Types of Mortgages

1. Conventional mortgage – requires a minimum down payment of 20% of the purchase price. The maximum amortization period is 30 years. Terms vary from one to five years and the interest rate can either be fixed or variable. (open mortgages are also available)

2. High ratio mortgage (less than 20% down) – is insured with the Canadian Housing and Mortgage Corporation. (CHMC) The insurance cost is based upon the amount of the down payment. The minimum down payment required is 5% of the purchase price and will cost the borrower about 3% to 3.5% of the value of the mortgage. The cost is added to the mortgage and the maximum amortization period is 25 years.

3. Secured line of credit – requires a minimum 35% down payment of the purchase price and requires a monthly payment equal to the interest charges.

Go on-line and google “How much house can I afford calculator”. Put in different amounts for down payment and try changing mortgage interest rates and amortization.

Here is one example: Using a RBC calculator

Total Family Income      $90,000.00       90,000.00
Total Debt              $0.00              $0.00
Monthly Mortgage Payment        $1,900.00         1,800.00
Interest Rate             3.50%             3.50%
Property Taxes / monthly             350.00           450.00
Heating Costs / monthly            150.00           150.00
Total Monthly housing cost        $2,400.00       $2,400.00
Down Payment           10.22%           20.33%
Dollar Amount       $42,000.00      $92,000.00
Mortgage Principal amount     $368,934.00      360,526.00
Default Insurance = 2.83%       $11,621.00              $0.00
Total Mortgage amount     $380,555.00     360,526.00
Amortization           25 years          30 years
Maximum Purchase price     $410,934.00     452,556.00

This example also illustrates that the cost of a high ratio mortgage can be expensive. It will take about 15 monthly mortgage payments to pay off the default insurance of $11,621 that was added to the mortgage total. I would be very careful when borrowing money to finance a house. You don’t want to be house poor, where you cannot afford other things in life.

Now you should establish a savings goal to buy your house.

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