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Buying a home is one of the biggest financial decisions you’ll ever make…but before you start house hunting, it’s important to determine how much you can afford.
Below, we share our step-by-step approach to calculating your budget, review how your bank will determine how much mortgage you can afford and give our best advice for making sure you don’t over-extend yourself.
How Much Can You Afford?
Step 1: Calculate Your Gross Household Income
The first step in determining your budget is to calculate your gross household income. This includes all sources of income for everyone who will be on the mortgage application. Be sure to include any bonuses, commissions, or overtime pay.
Gross Household Income = Income (before tax) of everyone on the mortgage application
Step 2: Determine Gross Debt Service (GDS) and Total Debt Service (TDS)
To determine the maximum amount of mortgage you can afford, Canadian banks will use two different calculations: Gross Debt Service Ratio (GDS) and Total Debt Service Ratio (TDS).
GDS Ratio Calculation:
Your GDS ratio is the percentage of your gross income that is needed to cover your housing expenses, including mortgage payments, property taxes, heating costs, and 50% of condo fees (if applicable). In general, lenders prefer a GDS ratio of 32% or less. If your downpayment is less than 20% and you need CMHC insurance, your GDS must not exceed 39%.
GDS = Mortgage payment + Property taxes + Heating Costs + 50% of Condo Fees ÷ Annual Income
TDS Ratio Calculation:
Your TDS ratio is the percentage of your gross income that is needed to cover ALL of your debt payments, including housing expenses, car loans, credit cards, and other debt. In general, lenders prefer a TDS ratio of 40% or less. If you need CMHC insurance, your TDS cannot exceed 44%.
TDS = Housing expenses + Credit card + Debt obligations ÷ Annual Income
You can calculate your GDS and TDS here.
Step 3: Consider Your Down Payment
Your down payment will affect the amount of mortgage you can afford, which in turn, determines your maximum house budget.
Homes Under $500,000
In Ontario, you’ll need a minimum downpayment of 5% of the purchase price for a home under $500,000. That means you can borrow up to 95% of the price of the home (assuming you qualify for a mortgage based on your income, credit score, assets and liabilities).
Example: $475,000 condo – Downpayment Required: $23,750
When your downpayment is less than 20%, you have to purchase mortgage default insurance (through CMHC, Genworth Financial or other companies). The premium of the insurance is calculated as a percentage of the mortgage and depends on the amount of your downpayment. Click here to calculate CMCH loan insurance.
Properties >$500,000 but < $1 Million
If the home costs more than $500,000 but less than a million dollars, you’ll need a minimum of 5% down on the first $500,000 and 10% on the remainder. You may also need to buy mortgage default insurance.
Example: $750,000 condo – Downpayment Required = ($500,000 * 0.05) + (250,000 * 0.10) = $50,000
Properties over $1 Million
For properties over 1 million dollars, you’ll need a 20% downpayment (but you won’t have to buy loan insurance).
Example: $1,300,000 house – Downpayment Required: $260,000
We wrote an in-depth article about downpayments here.
Step 4: Budget For Closing Costs
In addition to your down payment and monthly mortgage payment, you will also need to budget for closing costs, including land transfer taxes and legal fees.
Closing Costs: Before Closing
- Deposit (usually 5% of the purchase price, paid within 24 hours of your offer being accepted)
- Property Appraisal ($400- $500, often paid by the lender)
- Home Inspection ($400-700, paid to the home inspection company at the time of the inspection)
Closing Costs: On Closing
- Balance of Purchase Price (the purchase price less your initial deposit)
- Legal Fees ($1,800-3,000, depending on the value of the home)
- Title Insurance (sometimes included in your legal fees, $250-$400)
- Mortgage Broker Commission (if applicable, usually paid by the lender)
- Property Survey (if required – $1,000-$2,000)
- Ontario Land Transfer Tax (varies depending on the purchase price – see our Land Transfer Calculator)
- Toronto Land Transfer Tax (varies depending on the purchase price – see our Land Transfer Calculator)
- Property Tax Adjustment (reimbursement to Seller of property taxes they paid beyond the closing date)
- HST (generally only applicable on new construction condos and houses)
- Tarion Warranty Fees (warranty on new construction condos and houses only, not resale) – click here to estimate Tarion Fees
- Provincial Sales Tax (only applicable on chattels purchased from vendor – amount varies)
- Adjustments for Utilities/Condo Fees/etc (reimbursement to Seller for prepaid utilities, etc.)
- CMHC Insurance Premium (insurance premium charged if you have less then 20% down payment – click here to estimate CMHC insurance)
Closing Costs: After Closing
- Moving Expenses ($1,000+)
- Utility Connection Charges (varies)
- Redecorating and Renovating Costs (varies)
- Immediate Repair and Maintenance Costs (varies)
Step 5: Budget for Ongoing Costs
Once you’ve determined your maximum mortgage amount and budgeted for your down payment and closing costs, it’s important to also consider ongoing costs associated with homeownership, including:
- Property taxes
- Home insurance
- Condo fees
- Maintenance (1-3% of the value of your house)
Step 6: Talk to a Mortgage Professional
While online mortgage calculators can help you estimate how much you can afford, you really need to talk to a mortgage professional to understand your true budget.
Step 7: Make a Plan B
If there’s anything we can learn from homeowners with variable rate mortgages who’ve seen their mortgage payments skyrocket in 2023, it’s that you want to plan for the things you can’t predict:
- What happens if interest rates go up?
- What happens if you lose your job?
- What happens if the bonuses you’re used to receiving aren’t as big in the future?
- What happens if you get sick and are unable to work for a period of time?
- What happens if you get separated from your spouse or divorced?
- What happens if inflation continues to escalate and the cost of everything continues to increase?
- What happens if the cost of property taxes, utilities or insurance increases significantly?
Ways to Increase the Size of Your Home Buying Budget
It’s not unusual for potential home buyers to go through this process only to find out that they can’t afford to buy a home. Property prices in Toronto and the GTA are high, and it’s very possible that you may have to put your plans on hold until your budget aligns with the prices. In the meantime, here are some ways to increase the size of your budget:
- Increase your downpayment – a bigger downpayment means lower monthly mortgage costs (we wrote about strategies to increase your downpayment here)
- Increase your income through a side hustle or by searching for a new job
- Research mortgage options – how much you can afford is impacted by the type of mortgage you choose (variable rate or fixed rate), the length of amortization (eg 20, 25 or 30 years) and the interest rate
- Shop around for a better interest rate – you’ll be surprised by how your costs change based on the interest rate. Even a 0.1 lower rate can be substantial.
- Reduce your debt – Pay off those high-interest credit cards and explore options to pay off your other debts to be able to qualify to borrow a higher mortgage amount.
- Ask for help – In Canada, 41% of first-time homeowners (18-38 years old) get help from their parents, via a downpayment gift or loan or by co-signing or acting as a guarantor on the mortgage. We wrote about buying a home with your parents’ help here.
Be Careful Not to Over-Extend Yourself
While it may be tempting to stretch your budget to purchase your dream home, be wary of the risks of over-extending yourself. A higher mortgage payment can mean less disposable income for other expenses – retirement savings, emergencies and having a life.
Find out how much mortgage your bank is willing to lend you, make a detailed budget about how much you can afford, plan for contingencies….and then spend less than that.
One of the first steps of buying a home is determining how much can comfortably afford. Work with a professional mortgage broker or your banker and engage a real estate agent early in the process to help you make the right informed decision.