Affordability. It’s a word that gets tossed around a lot when people talk about homeownership, but what does it really mean? Affordability is a term that’s both quantifiable (lending institutions use a formula) and a little bit subjective (lifestyle considerations factor in, too). Here’s what you need to know about affordability, and what it means for you.
AFFORDABILITY, AS DETERMINED BY LENDERS
For lending institutions and mortgage insurers, affordability can be summed up by the debt service ratios, as indicated by your gross debt service ratio and total debt service ratio.
Gross debt service (GDS) ratio
- Homeownership costs (mortgage payments, property taxes, heating and, if applicable, 50% of condo fees), relative to household income
Total debt service (TDS) ratio
- Homeownership costs (as outlined above) plus debt payments (credit cards, lines of credit, student loans, car loans, etc.), relative to household income
To qualify for mortgage insurance (mandatory for any home purchase with a down payment of less than 20% of the cost of the home), the highest allowable GDS ratio is 39% and the highest allowable TDS ratio is 44%.
TIP: Get a quick snapshot of your current debt service ratios via Genworth Canada’s What Can I Afford? calculator.
AFFORDABILITY, AS DETERMINED BY LIFESTYLE
Although debt service ratios are an indicator of bottom-line affordability, other real-world factors should be considered up front by potential homeowners.
Expenses like groceries, child care, transportation, and mobile phone and Internet services, for instance, are not covered by TDS, but they’re more or less fixed costs for many households. While they don’t affect debt service ratios, they should be included in your own budget calculations, as they eat up a large chunk of income.
Discretionary expenses like clothing, entertainment, memberships and kids’ extracurricular activities should also be factored into affordability considerations. Are there any areas where you could cut back? Or will some expenses disappear, such as when a car is paid off or when a child leaves daycare for full-time school?
SET A BUDGET YOU CAN AFFORD
Between the numbers-driven debt service ratios used by banks, trust companies and mortgage insurers and the discretionary lifestyle expenses that also affect your bottom line, you will find what affordability means for you.
It’s never too early in your homeownership journey to speak with a mortgage professional or financial planner to determine how much mortgage you can comfortably carry. This will help you assess your financial fitness and also help you set realistic goals on an achievable timeline.
Source: Genworth.ca (Homeownership.ca)