If you’re considering buying a home in the near future, there is one critical question you should ask yourself. Before considering what type of home you’d like or what neighbourhood you’d like to live in, ask yourself: how much mortgage can I afford?
There are several rules of thumb that Canadians have used to determine how much you should be spending:
- Don’t spend more than 30% of your income on housing costs
- Your mortgage shouldn’t be more than 2.5 times your gross income
- Don’t spend more than 50% of your income on fixed costs like housing, debt, and necessities
But the reality is that Canadian home prices have been rising faster than incomes in Canada. While those rules might’ve worked for your parents, they might not work for you.
Let’s examine whether these rules of thumb are still realistic. Then we’ll look at some hard and fast rules that define how much mortgage you can afford.
Are Housing Rules of Thumb Still Realistic?
Is it realistic to only spend 30% of your income on housing? What about getting a mortgage for only 2.5 times your gross income? Let’s look at those rules in practice and hear from some experts on whether they are realistic today.
What is the 30% Housing Rule?
Spending a maximum of 30% of your income on housing is a rule of thumb that finance professionals have used for decades. But is it still accurate today? Let’s consider the average dual income in Canada and how much home that can buy.
In September 2023, the average home price in Canada was $655,507. If you were to get a mortgage at today’s mortgage rates with a minimum down payment, you can expect to pay $3,955 per month for your mortgage.
So, how much do you need to earn to afford an average home in Canada while sticking to the 30% housing rule? Your household would need to earn $13,183 per month, or $158,200 per year – just for the mortgage. Once you add in property taxes, insurance, and utilities, a high-earning household would still exceed the 30% rule on an average home in Canada.
That number would be even higher if you account for property taxes, insurance, and utilities. For anyone earning less or living in a city where home prices are above average, sticking to the 30% rule will be challenging, if not impossible.
That’s why sticking to spending less than 30% of your income on housing in today’s housing market may not be feasible. “This guideline has become increasingly difficult to achieve in Canada,” says Jason Heath, advice-only financial planner at Objective Financial Partners. “Because home prices have risen much faster than incomes over the past 20 years in Canada, more borrowers are being pushed to the upper end of their borrowing range.”
Canadians largely agree. In a recent survey, we asked homebuyers who purchased homes in the past four years what percentage of their income goes toward housing costs. The majority are spending more than the recommended 30%.
It’s safe to say old rules of thumb about housing costs don’t always work in today’s market. So how much should you really spend?
The Better Way to Find Out How Much Mortgage You Can Afford
Instead of using rules of thumb to determine how much you can afford, you’re better off determining a healthy mortgage-to-income ratio for your finances. This will depend on factors like your existing debt load and financial commitments like childcare costs. There are two tried and true calculations to determine how much you should spend on housing.
What’s a Healthy Mortgage-to-Income Ratio?
Lenders use two calculations to determine how much mortgage you can afford: the gross debt service ratio and the total debt service ratio. Lenders use these two ratios to determine how much mortgage you can afford.
Gross Debt Service Ratio
Your gross debt service ratio calculates your housing cost as a percentage of your gross income. The formula takes your home’s principal, interest, taxes, and heating costs and divides that amount by your total income. The resulting percentage cannot exceed 39%.
Let’s do an example calculation. Suppose you have a $150,000 annual household income or $12,500 monthly. To satisfy the GDS ratio, your monthly housing costs cannot exceed 39% of that amount or $4,875 per month.
Here’s what that might look like for a home with a purchase price of $675,000. We’ll assume a minimum down payment of $42,525 at today’s mortgage rates:
- Mortgage payment (principal and interest): $4,069
- Property Taxes: $563
- Heating Costs: $243
Total Debt Service Ratio
Your total debt service ratio is similar to the GDS but includes other existing debt you may have. This formula takes your home’s principal, interest, taxes, heating costs, and other debt obligations and divides that amount by your total income. The resulting percentage cannot exceed 44%.
Using the example above, if your household income is $150,000 annually or $12,500 monthly, the maximum you can spend on housing and other debts while satisfying the TDS ratio is $5,500.
How to Calculate How Much Mortgage You Can Afford
You can use these two ratios to calculate the maximum size of your monthly mortgage payment. Alternatively, you can use a mortgage affordability calculator, which does the work for you.
Once you know your maximum mortgage size, add that amount to your down payment to determine your maximum purchase price.
Why Mortgage Affordability Rules Don’t Always Work
While the GDS and TDS ratios are the gold standard for determining the maximum mortgage you can afford, that doesn’t mean you should spend up to your maximum affordability. In many instances, spending 39% of your gross income on housing would leave you with little left over.
For example, if you have additional expenses like childcare or if you are financially responsible for an elderly relative, spending 39% of your gross income on housing may mean you don’t have enough left over to save for retirement or other financial goals.
On the other hand, if you have no debt and no other financial obligations, spending 39% of your gross income on housing may still leave enough money in your budget for your other financial goals. Heath agrees. “I always discourage people from using their mortgage approval to dictate their housing budget,” Heath says.
“Just because a bank will lend you money doesn’t mean you should borrow it all. You have to look at your budget and what you spend the rest of your money on to determine how much of your after-tax income should be allocated towards housing. “
Your Mortgage Payment Should Fit Your Budget
If you are unsure how much mortgage you can afford, a great place to start is your budget. Look at how much you earn and subtract your fixed and variable expenses. Make sure to account for saving for your future and other costs that may come up after purchasing a home. What is left over is how much you can afford to spend on housing.
Unfortunately, how much mortgage you can afford is different for everyone. That’s why these easy rules of thumb have become popular in the first place. While those rules attempt to simplify the question of how much mortgage you can afford, they don’t consider your unique financial circumstances. That’s why it’s essential to calculate your GDS and TDS ratio. You can use that information and your existing budget to determine how much mortgage you can comfortably afford.
FAQs
How much should you spend on housing costs?
According to the gross debt service ratio, you should spend at most 39% of your gross household income on housing. Housing includes your mortgage principal and interest, heating costs, and property taxes.
How much should you spend on rent?
A common rule of thumb is not to spend more than 30% of your gross income on rent. However, this is just a guideline. How much you’ll spend will depend on factors like your fixed costs and debt load.
How much should you spend on a mortgage?
A common rule of thumb is not to spend more than 30% of your income on your mortgage. However, this rule of thumb might not be feasible in areas with high housing costs.
