The second affordability rule is that your entire monthly debt load shouldn’t be more than 40% of your gross monthly income. This includes housing costs and other debts, such as car loans and credit card payments. Lenders add up these debts to determine what percentage they are of your gross household monthly income. This figure is your Total Debt Service (TDS) ratio.

Use the table below to calculate your TDS ratio and to determine the monthly housing costs you can afford after making other monthly debt payments.

Your Maximum Home Price

The maximum home price that you can afford depends on a number of factors but the most important are your gross household income, your down payment and the mortgage interest rate.

For most people the hardest part of buying a home – especially the first one – is saving the necessary down payment. Many people will not have 20% of the purchase price to put down. With mortgage loan insurance, you can purchase a home with little or no down payment. Mortgage loan insurance protects the lender and, by law, most Canadian lending institutions require it. The way it works is if the borrower defaults (fails to pay) on the mortgage, the lender is paid back by the insurer. The cost for this type of insurance is in the form of a premium and can be paid in a single lump sum or it can be added to your mortgage and included in your monthly payments. Generally, a down payment comes from your own resources. However, if you have a good credit history and an income to support the financial obligations of homeownership, you could benefit from CMHC’s Flex Down product. The Flex Down product allows homebuyers to obtain up to 5% of the down payment from virtually any source, including lender incentives and borrowed funds, provided that the source is arm’s length to the purchase or sale of the property.

Here are CMHC’s premiums:

Other important factors to consider when determining your maximum home price are your personal preferences and your calculations from earlier on in this chapter.

Get a Mortgage Pre-Approval

Once you’ve made the necessary calculations and feel that you are ready to obtain a mortgage, it’s a good idea to select a lender to get pre-approved. This means that the lender will look at your finances to establish the amount of mortgage you can afford. At that time, the lender will give you a written confirmation or certificate for a fixed interest rate good for a specific period of time. Some buyers may not wish to pursue a mortgage pre-approval until they have found the home they want to buy. However, the idea of having a pre-approved mortgage amount makes the search for your new home much easier and less time-consuming because you have a good price range in mind.

Some things you will need to have with you the first time you meet with a lender:

• Your personal information, including identification such as your driver’s license

• Details on your job, including confirmation of salary in the form of a letter from your employer

• Your sources of income

• Information and details on all bank accounts, loans and other debts

• Proof of financial assets

• Source and amount of down payment and deposit

• Proof of source of funds for the closing costs (these are usually between 1.5% and 4% of the purchase price)

Will You Have Trouble Qualifying for a Mortgage?

Your calculations may show that you will have trouble meeting monthly debt payment and that you will likely have trouble getting approved for a mortgage.

Here are some things you can do:

• Pay off some loans first

• Save for a larger down payment

• Revise your target house price

Other Helpful Strategies

• Meet with a credit counsellor who can help you minimize your debts.

• Buy your home through a rent-to-own program provided by the builder, a non-profit sponsor or a government sponsor.

• Find out about programs through which you can help build your own home.

• Ask the housing department of your municipality about any special programs available.

The Importance of Your Credit Rating

Before approving you for a mortgage, lenders will want to see how well you have paid your debts and bills in the past. To do this, they simply get a copy of your credit history (credit report) from a credit bureau. This provides them with information on your financial past and use of credit. Before your lender sees your credit history, you should get a copy for yourself to make sure the information is complete and accurate. Simply contact one of the two main credit-reporting agencies (Equifax Canada Inc. or TransUnion of Canada) to get a copy of your credit report. There is often a fee for this service.

Lack of Credit History

If you have no credit history, it is important to start building one by, for example, applying for a standard credit card with good interest rates and terms, making small purchases and paying them as soon as the bill comes in.

Fixing a Credit Record

If you have bad credit, lenders might not want to give you a mortgage loan until you can re-establish a good credit history by making debt payments regularly and on time. Most unfavourable credit information, including bankruptcy, is dropped from your credit file after seven years. If you have bad credit, you may want to consider credit counselling. Despite your poor credit history, you might still be able to get a mortgage loan if you have a relative such as a family member willing to be a guarantor or co-signer on the loan. This person must meet the lender’s borrowing criteria, including good credit history, and is legally obligated to make the mortgage payments if you do not.

KEY MORTGAGE TERMS & DEFINITIONS

Mortgage Approval

A pre-approved mortgage certificate is not a guarantee of being approved for the mortgage loan. Even if you have a pre-approved mortgage certificate, you must still meet your lender during the conditional offer period to get a final mortgage approval. To ensure that the process goes smoothly, make sure you bring:

• A copy of the property listing

• A copy of the signed Offer to Purchase

Your lender will update/verify your financial information, the property and other information required to complete the mortgage application. Your lender may require an appraisal and/or a survey. Title insurance may also be required. Your lender will also inform you on the various types of mortgages, terms, interest rates, amortization periods and payment schedules available. Depending on your down payment, you may have a conventional or high-ratio mortgage.

A conventional mortgage is a mortgage loan that does not exceed 80% of the lending value of the property. The lending value is typically the lesser of the property’s purchase price and market value. Your down payment is at least 20% of the purchase price or market value.

If you contribute less than 20% of the home price as a down payment you will typically need a high-ratio mortgage. This type of mortgage usually requires mortgage loan insurance, of which CMHC is a major provider. Your lender may add the mortgage insurance premium to your mortgage or ask you to pay it in full upon closing. (Refer to Step 2 for details.)

Fixed, Variable or Adjustable Interest Rate

Mortgage interest rates are either fixed, variable or adjustable. A fixed rate is a locked-in rate that will not increase for the term of the mortgage. A variable rate fluctuates based on market conditions while the mortgage payment remains unchanged. With an adjustable rate, both the interest rate and the mortgage payment vary based on market conditions.

Closed Mortgage

A closed mortgage may be a good choice if you’d like to have a fixed payment that will allow you to adjust your budget to your new lifestyle. However, closed mortgages are not flexible and there are often penalties or restrictive conditions attached to prepayments or additional lump sum payments. It may not be the best choice if you decide to move before the end of the term or if you want to benefit from a potential decrease of interest rates.

Open Mortgage

This type of mortgage is flexible and can usually be pre-paid by any lump sum or paid off at any time without penalty. An open mortgage can be a good choice if you plan to sell your home in the near future or to pre-pay with large lump sums. Most lenders will allow you to convert to a closed mortgage at any time, although you may have to pay a small fee.

Term

Your lender will also inform you on the term options for the mortgage. This is the length of time that the agreed-upon mortgage contract conditions, including interest rate, will be fixed. It can vary from six months to ten years. Choosing a longer term (e.g.: five years) gives you the chance to plan ahead and protects you from interest rate increases while you adjust to homeownership. Weigh your options carefully and don’t be afraid to ask your lender to work out the differences between a one, two, five-year term or longer term.

Amortization

This is the amount of time over which the entire debt will be repaid. Most mortgages are amortized over 25 years, but longer periods are available. The longer the amortization, the lower your scheduled mortgage payments, but the more interest you pay in the long run.

Payment Schedule

A mortgage loan is often repaid in regular payments, either monthly, biweekly or weekly. Payment schedules that are more frequent can save some interest costs by reducing the outstanding principal balance more quickly than with monthly payments. The more payments you make in a year, the lower the overall interest you have to pay on your mortgage. Keep in mind that mortgages may have important payment features that can save you money and let you be mortgage-free sooner.