If you are like most people,
you have an image of your dream home tucked somewhere in your
mind. But can you afford it? A house is too expensive to be an
"impulse" buy. Your dream home becomes a nightmare when
you end up "house poor", with most of your money going
to pay for the mortgage and little left over for enjoyment.
When buying a home, you need
to be practical and realistic. Over-extending yourself financially
is the quickest way to destroy the excitement of owning your own
home.
A real estate professional can
help you find a home that you both love and can afford. A realtor can also assist you in evaluating your mortgage options and obtaining
financing at the most attractive prevailing rate. In the meantime,
here are some ways to determine your affordability quotient.
What You Can Afford to Buy
Setting
a maximum price range is more important than simply establishing
an upper price limit because unanticipated costs could push you
into the "house poor" danger zone. To determine your
affordability price range, you must calculate two amounts: the
amount of cash you can afford to put towards the purchase (the
downpayment) and the maximum amount of loan (mortgage) you can
comfortably carry.
About the Downpayment
A
mortgage covers the difference between the purchase price and
your downpayment. The larger the downpayment, the less you have
to borrow, the smaller your monthly mortgage payment, and the
lower your cost of interest over the term of the mortgage. It
makes sense, therefore, to put down as much of your own money
as possible.
You should keep a cash reserve
for unexpected expenses and such typical "post purchase"
expenses as taxes, legal fees, mortgage arrangements, moving expenses,
new furnishings and appliances.
How Much You Can Afford to
Borrow
The first step towards establishing
a maximum mortgage limit is to calculate a monthly payment you
can afford. Financial institutions do this by calculating your
debt service ratio (DSR).
To calculate your DSR, list
all your loans (car, personal loans, monthly credit card balances).
The sum of these loan payments and your mortgage payment (including
principal, interest and taxes) should not exceed 40 per cent of
your gross income.
A faster way of calculating
your debt service ability is to use the gross debt service (GDS)
formula. In this case, the principal, interest and taxes (PIT)
on your mortgage loan should not exceed 30 per cent of your gross
income.
Increasingly, financial institutions
tend to include the energy costs to the PIT formula, in which
case the GDS moves from 30 per cent to 32 per cent of gross income.
Some final thoughts on affordability.
In addition to the DSR, the lender will also be looking at your
overall credit rating, the number of years at your present job
and other factors in assessing you as a loan risk.
Interest Rates and Other
Variables
The size of the mortgage you can arrange, based
on payments you can afford, depends on interest rates. The lower
the rate, the larger the possible mortgage and the more affordable
housing becomes.
The rate of interest is not
the only factor, however, there are other mortgage terms to consider
as well. How open is the mortgage? Would prepayment be allowed?
Is the mortgage portable?
Discuss your mortgage options
with a realtor, your banker or a financial advisor. Establish
a limit and stick to it.
Where to Get a Mortgage
The usual source of mortgage funds is a lending
institution such as a bank or trust company, and it is the particular
policy of the lending institution that determines the maximum
loan allowed. But there are other sources of funding, too, and
a realtors can help you choose the best lender at the best rate
and terms.
Above all, don't be afraid to
ask questions. Realtors have a broad knowledge of mortgages and
can make recommendations that save you time and effort as you
look for a dream home that won't stretch your budget to the breaking
point.
Prepared by the Alberta Real
Estate Association
