When it comes to applying for a mortgage, homebuyers tend to focus on how much they’ll be approved for, rather than what they can actually afford to spend on a home.
However, the maximum you can borrow through a mortgage only determines on average how much someone in a similar financial situation might be able to afford to pay towards their monthly mortgage payment. Your unique financial situation might be very different than the average person’s and the amount you might be able to afford to borrow for a mortgage might be less than you're approved for. For example, you might have significant additional expenses like childcare that would make it challenging for you to pay the maximum monthly amount that you're approved for.
You need to also think about your lifestyle, which can vary from borrower to borrower. You may choose to live in a more expensive part of the country with higher property taxes and higher costs of living. When you purchase a home that exceeds what you can realistically afford, you may find yourself in a difficult financial situation.
So, how do you know just how much you can afford in a home? We walk you through some of the things to consider before you apply for a mortgage.
An important thing to consider before deciding how much you can afford is how much you have available to put towards a down payment. This will not only impact how much you end up borrowing, but, depending on the size of your down payment, it could involve additional expenses.
If you don't have at least 20% for a down payment, you will have to pay for mortgage default insurance. This type of insurance protects the lender in case you default under your mortgage. That can tack on a lump sum fee or an addition to your mortgage to cover the mortgage default insurance premium. For that reason, it's important that you include this expense as part of your homebuying budget.
Figuring out how much you can afford to put towards your monthly mortgage payments isn’t always an easy decision. It involves sitting down, going through your finances and looking at what you've been spending over the last year.
Here are a few of the things you need to look at:
Doing a deep dive into your monthly expenses is critical to understanding how much money you have to put towards a mortgage payment. However, monthly expenses vary throughout the year so your best bet will be to review the amount of money you spent over the last year and average out that amount. After all, there are months when you might spend more – like in December during the holiday season or during months when you may have taken a vacation or renewed your auto insurance.
When reviewing your finances, be sure to include any fixed expenses like your phone bills, utilities, debt payments, car payments, and childcare costs. Also be sure to include variable expenses like gifts for others, travel, and other luxuries you can't do without. While you might decide that there are things that you're willing to do without in order to make a new home a reality, don't create a budget that will leave you unhappy over time.
For many people, determining gross monthly income is simple if they work for an employer and their income remains stable. But for others, variable income might be a reality because they may freelance, own their own business, or rely on fluctuating commissions or bonuses. If you freelance, it’s important to consider your monthly cash flow because sometimes clients don't pay on a monthly basis or may take a longer time to pay invoices. If that's the case, you could end up with a mortgage payment due and no household income coming in that month. This should definitely factor into how much you can take out in a mortgage loan.
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Interest rate by credit score
How much you can borrow will likely also be impacted by your credit score. A credit score is one important way lenders determine the risk of lending to any individual based on their credit history. They then decide how much to lend to someone and how much to charge that person in interest based, in part, based on that number. If you don't have a great credit score, you might not be able to qualify to borrow as much as someone in similar financial circumstances as you who a better score. Or, you might have to pay a higher mortgage rate than another borrower. That would have a substantial impact on your monthly payment and the overall affordability of your mortgage. For that reason, you might decide to take out a smaller mortgage loan.
There are other ways your mortgage interest rate could impact how much you can afford in a home. While the interest rate you're able to qualify for is critical, the type of interest rate you select is equally important. With mortgages you can choose either a variable interest rate or a fixed interest rate. Variable interest rates could be lower, but they vary over the life of your loan depending on how much your lender’s prime lending rate fluctuates over time. That means that if you choose a variable interest rate mortgage, your monthly payments could change in the future. It's important that you have the flexibility to adjust your budget if you choose a variable rate mortgage. In contrast, a fixed rate mortgage charges the same interest rate over the term of the loan. That means that your monthly payment will remain the same from your first payment to your last during your selected term. If you don't have much wiggle room in your budget, this might be a better choice for you.
There are a few types of taxes you’ll need to consider as a homebuyer. The first is property tax. You can check the city or municipality that you’ll be living in to see how much they typically charge in property tax to estimate your payment. However, you can also ask before buying a home how much it has been assessed for.
Another tax you might need to consider is if you are buying a brand-new home that has just been built. If you buy a new construction home or condominium, you have to pay GST/HST on it – that's 5% in GST and 13% in HST that you have to tack onto your purchase price. You might be eligible, however, for a partial GST rebate if your home is priced under $350,000.*
Buying a home involves several costs in order to complete the purchase such as title insurance, legal fees, land transfer taxes, home inspection fees, appraisal fees, real estate agent commissions, and other expenses. These generally add up to several thousand dollars and should be accounted for from the onset.
Before you decide on how much you can afford, it's important to consider the insurance costs that you will have as these can add up. You will need to pay for mortgage default insurance if your down payment is under 20% of your purchase price. How much you will pay will largely depend on how much your down payment is.
You might also want to get a supplementary mortgage creditor insurance that will cover you in case you experience certain unexpected events over the term of your loan. Mortgage protection insurance can cover borrowers in the event that they pass away, experience a covered critical illness, or become disabled while repaying their mortgage loan. It's a great way to protect your investment as a result of certain unexpected life events.
Finally, you will need homeowner’s insurance to cover your home for a variety of situations like theft, fire, or weather damage. Property insurance is critical to protect what is likely to be your largest investment and is required by the lender when you get a mortgage.
There are all sorts of other expenses you should consider when figuring out how much of a home you can realistically afford. From things like condo fees to maintenance fees and renovations, you’ll have to consider these expenses in full. Being a homeowner also involves paying for occasional repairs or replacements of appliances or other similar expenses. You might also need to budget money to purchase new furniture or even, decorate your new place. Keep in mind that all of these expenses add up.
One way to help you figure out how much you should spent towards your mortgage is to use a home affordability calculator. This is an online calculator that prompts you to think about all your monthly expenses. It also considers other expenses that you might not consider upfront to help you determine how affordable home ownership would be for you, like are you planning on making renovations and your other financial goals like paying for your child’s education.
It's important to carefully consider the affordability of your new home in the context of your personal financial situation. Once you understand the mortgage you can afford, getting a mortgage is a pretty simple process with online mortgage hubs like Scotia's eHOME, which allows you to get pre-approved, search for a home and get mortgage approval all in one place, all online.
Legal Disclaimer: This article is provided for information purposes only. It is not to be relied upon as investment advice or guarantees about the future, nor should it be considered a recommendation to buy or sell. Information contained in this article, including information relating to interest rates, market conditions, tax rules, and other investment factors are subject to change without notice and The Bank of Nova Scotia is not responsible to update this information. All third party sources are believed to be accurate and reliable as of the date of publication and The Bank of Nova Scotia does not guarantee its accuracy or reliability. Readers should consult their own professional advisor for specific investment and/or tax advice tailored to their needs to ensure that individual circumstances are considered properly and action is taken based on the latest available information.
All Scotiabank mortgage applications are subject to Scotiabank’s, and if applicable, the mortgage default insurer’s, standard credit criteria, residential mortgage standards and maximum permitted loan amounts.