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. For that reason, the amount you might be able to afford to borrow might be less than what you're approved for. For example, you might have significant additional expenses like childcare or you could have a more expensive lifestyle. Maybe you like to go on more vacations or you live in an area with a very high cost of living.

When you purchase a home for more than 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’ll walk you through some of the things to consider before you apply for a mortgage.

How much is your down payment?

One 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, you may be required to pay for mortgage default insurance as well.

If you don't have at least 20% of the purchase price or appraised value (whichever is lower) to put towards a down payment, you will have to pay for mortgage default insurance. This could result in having to put down more than 20% of the purchase price if the property is appraised lower than the purchase price since you’ll have to put 20% of the appraised amount down plus the difference between the appraised amount and the purchase price. 

Mortgage default insurance protects the lender in case you default under your mortgage. That can mean 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.

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How much can you afford monthly?

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 – and anticipating how much you’ll spend once you become a homeowner.

Here are a few of the things you need to look at.

Monthly expenses

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 that you would like to maintain. 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.

Monthly income

For many people, determining gross monthly income is simple. If you work for an employer, your monthly income often 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 to pay for it. This should definitely factor into how much you can afford in a mortgage loan.

Monthly debt payments

If you have debt, whether it be in the form of an auto loan, student loans, a personal loan, a line of credit, or credit card debt, your monthly debt payments impact how much you can borrow. This isn't just because paying for debt is a monthly expense that you should factor in, but also because how much debt you have directly affects how much you can qualify for when applying for a mortgage.

There are a couple debt service ratios that come into play when you are looking to get a mortgage – like the maximum gross debt service ratio, that is, how much of your gross income goes to your mortgage, and the maximum total debt service ratio, that is, how much of your income can go towards various forms of monthly debt repayment, including your mortgage.

The allowable debt service ratios for you to qualify for a mortgage will vary depending on different factors like if your mortgage is insured and your default insurance provider. 

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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. Based in part on the person’s credit score, the lender will decide how much to lend to them and what rate of interest they qualify for. If you don't have a great credit score, you might not qualify to borrow as much as someone in similar financial circumstances who has a better credit score. Or, you might have to pay a higher mortgage rate than another borrower, which would have a substantial impact on your monthly payment and the overall affordability of your mortgage. For that reason, you might decide or might need to take out a smaller mortgage loan.

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Mortgage interest rate

Your mortgage interest rate can impact how much of a mortgage you can afford in a number of ways. 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 are typically lower than fixed rates, but they may vary over the life of your loan in line with changes to the Bank of Canada’s overnight lending rate. That means that if you choose a variable interest rate mortgage, your monthly payments could change in the future by going up or down. Because of this possible fluctuation, if you choose a variable rate mortgage, it’s important that you have the flexibility to adjust your budget for mortgage payments. 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.

How much are taxes?

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 annually in property tax to estimate your payment when assessing your budget. However, you can also ask before buying a home how much it has been assessed for. Property tax will be due in monthly installments or billed quarterly, depending on your municipality. 

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 or 13% to 15% in HST (depending on the province you live in) that you will have to add to your purchase price. You might be eligible, however, for a partial GST rebate if your home is priced under $350,000.*

How much are closing costs?

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.

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Mortgage and property insurance

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. For example, 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 protect you in case you experience certain unexpected events over the term of your loan. Mortgage protection insurance can cover borrowers in the event of their death, experiencing a covered critical illness, job loss, or becoming disabled while repaying their mortgage loan. It’s a great way to protect your investment in the case 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.

What are other homeownership expenses?

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.

Home affordability calculator

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 — such as whether you are planning on renovating your new place and if you have other financial goals like paying for your child's education.

The bottom line

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 Scotiabank eHOME, which allows you to search for a home and get mortgage approval all in one place, all online. 

Ready to talk about how to choose the right mortgage for you? Book an appointment with a home financing advisor