Wednesday, April 18, 2012

A sobering reminder; can you reasonably afford the house you want?

Just because a mortgage lender (ie. me and the lenders I work with) tells you that you qualify for a mortgage doesn’t mean you should run out and buy the first house for the full amount of your pre-approval. I encourage you stop for a minute and do a few basic calculations to ensure that, should you purchase a home for the maximum amount that you are pre-approved, you will be able to comfortably make your mortgage payment and still afford to live.

The article below does a really good job of explaining how I would qualify you for a mortgage versus how you may want to qualify yourself. This article actually explains CMHC’s mortgage guidelines in a conservative way, explaining that mortgage lenders allow you to use up to 40% of your gross income for housing. The figure is actually 44% if you have excellent credit. That’s right folks. 44% of your gross (pre-tax) income. What this means in reality is that if you earn an annual salary of $60,000 a year or $5,000 a month, and you have excellent credit as well as an overall strong file (and no other debts) you can use up to 44% of your monthly income to go towards your mortgage payment, property tax and heat. 44% of $5,000/month is $2,200.

Do you think that would leave you enough to live on every month? It’s a good question to ask yourself before you start house hunting!

Please keep in mind that the above figures do not account for additional living expenses that you may have including power, car insurance, gas, food, entertainment expenses, cell phone bills, cable/internet/telephone etc.

A reality test for would-be home buyers

By Rob Carrick

From Tuesday's Globe and Mail

Published Monday, Apr. 16, 2012 6:25PM EDT

Last updated Tuesday, Apr. 17, 2012 11:32AM EDT

Never ask anyone who lends money if you can afford a house.

Lenders care about their own money. Not yours. So while you’re thinking about how you’ll manage the cost of a mortgage and all your other living expenses, lenders seek the answer to one single question: How much risk is there that this person will not repay our money on time?

Not that lenders are oppressively picky. The more they lend, the more they make in interest. So there are no high hurdles in deciding who gets a mortgage. Partly, that’s because lenders know they have human nature working for them. If a family is having trouble paying its bills, you can be sure the mortgage will come first.

There are plenty of mortgage affordability calculators online, but they use the lender’s criteria for the most part. So let’s see what we can do to develop some simple rules that will help you understand how well you can manage the cost of owning a home.

Helping us out is Jeff Schwartz, executive director of the non-profit Consolidated Credit Counseling Services of Canada. His agency helps people overwhelmed by their debts, and he knows how problems start. “We see the remnants of people who haven’t kept their financial house in order.”

Where lenders base their analysis on gross income, Mr. Schwartz suggested using take-home pay because it corresponds to what people actually have to spend.

His basic guideline: The monthly cost of your mortgage and property taxes, plus the monthly portion of your annual home insurance bill, should not eat up more than 25 to 30 per cent of your monthly net pay.

Sure, you could push it higher. In fact, Mr. Schwartz said some clients of his agency have housing costs as high as 50 per cent of their take-home pay. “That means they’re eating Kraft Dinner to be able to afford the house they’re living in. They’re making sacrifices somewhere else.”

Capping housing costs at 30 per cent will keep some people out of the housing market, which is fine. They can rent and keep saving to build a bigger down payment. In the housing market, fools rush in.

Those who follow this guideline in buying a home will enjoy three major benefits, the first being that they’ll have room to save for retirement and for their kids’ post-secondary education. Mr. Schwartz figures a goal of saving 10 per cent of your take-home pay is realistic if you cap your housing costs at 30 per cent.

Another benefit of the 30-per-cent ceiling for housing is that it gives you enough financial slack to absorb higher costs in the future. Higher interest rates could push up the cost of your mortgage on renewal, for example. Mr. Schwartz said rising household utility bills are also an issue.

A final benefit of the 30-per-cent rule is that it leaves you with enough money to cover all the usual living costs, as well as a reasonable level of additional debt.

For some perspective on the 30-per-cent rule, let’s check with David Larock, a banker turned mortgage broker. He found this a tough standard and notes that young adults buying homes should find the costs more manageable as time passes and they move into their peak earning years.

Mr. Larock also said that people who buy a smaller, more affordable home may find they have to move in a few years. “Moving is bloody expensive – you have to pay real-estate commissions and land-transfer taxes, you’ve got to move everything. Being ultra-conservative can sometimes end up causing more harm than good.”

The problem with buying a larger home is that it will cost you more, and that means you’ll either have to save a larger down payment or stretch yourself and pay more in mortgage costs. Very likely, lenders will accommodate you on that.

The lender’s key metric for deciding how much you can borrow is the total debt service ratio, which measures your pre-tax pay against the cost of your mortgage, property taxes, heating and any other debts you have. The maximum mortgage payment is supposed to take up to 40 per cent of your gross pay, but Mr. Larock said people with solid but not outstanding credit scores may be allowed to go up to 42 or even 44 per cent.

The first casualty of being over-mortgaged is savings. “Your lender doesn’t care if you have enough money to save for retirement,” Mr. Larock said. “That doesn’t enter their thinking.”


Can You Afford To Buy A House?

Let's say a young couple want to buy a house in a community where the average price of a detached home is $400,000. Here's how they might assess their ability to carry the cost of buying a home. This analysis was done using guidelines suggested by Jeff Schwartz, executive director of Consolidated Credit Counselling Services of Canada. To keep things simple, it's assumed here that both spouses have cleared all their debts in preparation to buy a home.

After-tax-income (using Ontario rates) *

One spouse makes $50,000 $41,113

The other spouse makes $40,000 $34,038

Total household income $75,151

Household after-tax income per month $6,263
The recommended ceiling for spending on a house is 25 to 30 per cent of net household income (covers mortgage + property taxes + insurance)


x 30%


Monthly payment on a $400,000 home bought with a 5% downpayment $1,706 five-year fixed mortage rate of 3.29%, 30-year amortization, includes mortgage insurance costs

Estimated monthly house insurance cost $66 based on a $800 annual premium

Estimated monthly property tax bill $333 based on a $4,000 annual bill

$2,105 Total monthly housing cost

Verdict: Unaffordable

Suggestion: Save a larger downpayment and borrow less, or find a cheaper home

The Bank's View On Mortgage Lending

Banks use the total debt service ratio, which says the cost of housing plus carrying costs for other debts should not exceed 40% of your pre-tax income
Gross monthly household income for the couple in our example $7,500 ($90,000/12)

x 40%

Maximum a lender would let them spend on a house per month, assuming no other debts. $3,000

* Source: Ernst & Young 2012 personal tax calculator (


Further budgeting guidelines for first-time home buyers

Assumption: Family of four

(Data supplied by Consolidated Credit Counseling Services of Canada)

If you borrowed as much as the bank would lend you ($) If you stuck to the 30% ceiling on housing costs ($)

Net monthly income 6,263.00 6,263.00

Monthly expenses
Mortgage 3,000.00 1,706.00

Home insurance 66.00 66.00

Property Taxes 333.00 333.00
Savings 626.00 626.00 10% of net income - a suggested guideline

Other Debt 626.00 626.00 10% of net income - a suggested ceiling

Utilities 313.15 313.15 5% of net income

Food 626.30 626.30 10% of net income

Transportation 1,565.75 1,565.75 25% of net income (auto payments, auto insurance, gas, maintenance, licensing, parking)

Clothing 125.26 125.26 2% of net income

Dining Out/Personal/Pets/Smoking/Misc 313.15 313.15 5% of net income
 Total Expenses: 7,594.61 6,300.61

Surplus/Deficit -1,331.61 -37.61 based on monthly takehome pay of $6,263

Verdict Unaffordable Affordable with modest adjustments, like cutting non-mortgage debt

Tuesday, April 17, 2012

I'm starting to sound like a broken record!

In today’s announcement by the Bank of Canada, the key interest rate has remained unchanged at 1%. This means no change to the prime lending rate charged by financial institutions (and consequently no changes for variable or Home Equity Line of Credit borrowers). The next interest rate announcement is scheduled for June 5th 2012.

Here is an excerpt from the Bank of Canada’s release:

Ottawa, Ontario -
The Bank of Canada today announced that it is maintaining its target for the overnight rate at 1 per cent. The Bank Rate is correspondingly 1 1/4 per cent and the deposit rate is 3/4 per cent.
The profile for global economic growth has improved since the Bank released its January Monetary Policy Report (MPR). Europe is expected to emerge slowly from recession in the second half of 2012, although the risks around this outlook remain high. The profile for U.S. growth is slightly stronger, reflecting the balance of somewhat improved labour markets, financial conditions and confidence on the one hand, and emerging fiscal consolidation and ongoing household deleveraging on the other. Economic activity in emerging-market economies is expected to moderate to a still-robust pace over the projection horizon, supported by an easing of macroeconomic policies. Improved global economic prospects, supply disruptions and geopolitical risks have kept commodity prices elevated. In particular, the international price of oil has risen further and is now considerably higher than that received by Canadian producers. If sustained, these oil price developments could dampen the improvement in economic momentum.
Overall, economic momentum in Canada is slightly firmer than the Bank had expected in January. The external headwinds facing Canada have abated somewhat, with the U.S. recovery more resilient and financial conditions more supportive than previously anticipated. As a result, business and household confidence are improving faster than forecast in January. The Bank projects that private domestic demand will account for almost all of Canada’s economic growth over the projection horizon. Household spending is expected to remain high relative to GDP as households add to their debt burden, which remains the biggest domestic risk. Business investment is projected to remain robust, reflecting solid balance sheets, very favourable credit conditions, continuing strong terms of trade and heightened competitive pressures. The contribution of government spending to growth is expected to be quite modest over the projection horizon, in line with recent federal and provincial budgets. The recovery in net exports is likely to remain weak in light of modest external demand and ongoing competitiveness challenges, including the persistent strength of the Canadian dollar.
The Bank projects that the economy will grow by 2.4 per cent in both 2012 and 2013 before moderating to 2.2 per cent in 2014. The degree of economic slack has been somewhat smaller than the Bank had anticipated in January, and the economy is now expected to return to full capacity in the first half of 2013.
As a result of this reduced slack and higher gasoline prices, the profile for inflation is expected to be somewhat firmer than anticipated in January. After moderating this quarter, total CPI inflation is expected, along with core inflation, to be around 2 per cent over the balance of the projection horizon as the economy reaches its production potential, the growth of labour compensation remains moderate, and inflation expectations stay well-anchored.
Reflecting all of these factors, the Bank has decided to maintain the target for the overnight rate at 1 per cent. In light of the reduced slack in the economy and firmer underlying inflation, some modest withdrawal of the present considerable monetary policy stimulus may become appropriate, consistent with achieving the 2 per cent inflation target over the medium term. The timing and degree of any such withdrawal will be weighed carefully against domestic and global economic developments.
Information note:
A full update of the Bank’s outlook for the economy and inflation, including risks to the projection, will be published in the MPR on 18 April 2012. The next scheduled date for announcing the overnight rate target is 5 June 2012.