I can’t be the only person who has spent a lot more time scrolling real estate listings on my phone during the pandemic.
Now, in my case it’s purely recreational; we love our house and we especially love Not Moving. But daydreaming about moving to a gorgeous stone house in the country? Sign me right up.
However, there are definitely people who are looking much more seriously, especially if your current work-from-home situation isn’t ideal. Judging from the hot housing markets in a lot of places (Ottawa is truly eye-popping right now!) that’s a lot of you.
That’s why I want to talk about the different rules of thumb available to help you figure out what you can afford before you’re in the middle of bidding on a house you absolutely love. Trust me, your future self who can still afford to eat at restaurants (when they’re a thing again) will thank you!
There’s plenty of advice out there, so I wanted to round up some of my favourite guidelines. That way, you can choose your own house-budgeting adventure — because remember, buying a house can be fun!
Test 1: Multiply your income by X
The quickest gut check to do on your home-buying budget is to divide your ideal home price by your (pre-tax) annual income.
Say you want to buy a house for $500,000. Divided by your pre-tax household income of $150,000, you get 3.33. Your home would be 3.33 times your annual income.
Recommendations for a good multiplier have differed slightly over the years, especially as so many housing markets have drastically outpaced income growth. When I was first looking at buying a place, the steadfast rule was: “Don’t buy a place that’s more than three times your annual income.”
Since then, I’ve heard recommendations that are more flexible, with any multiple between three and four being fine, and multiples over four being a “pursue at your own risk.”
If you’re looking at a place that’s more than four times your annual income, it’s worth doing further calculations to make sure you’re on solid footing. You probably want to save up for a larger down payment, too, so your mortgage is smaller and your yearly cashflow isn’t as big of a deal. (A good high-interest savings account can help — EQ Bank is my favourite, no question.)
Test 2: Check your debt service ratios
Any mortgage provider will check your debt service ratios when you go in to apply, so it’s not absolutely necessary to know ahead of time. But it can really help you plan on a home budget that makes sense for your actual finances.
There are two that matter for getting a home:
- your gross debt service ratio, which is the percentage of your pre-tax monthly income that will go to housing expenses, and;
- Your total debt service ratio, which is the percentage of your pre-tax monthly income that will go to all of your debt payments and housing expenses.
Before you get your own place, your total debt service ratio is hopefully pretty low. Maybe a car payment and some student loans, but hopefully well within manageable limits.
The reason this comes up in the home-buying process is that a mortgage will add a significant chunk of debt to your monthly responsibilities, and mortgage issuers want to make sure that you don’t have too much debt.
Canada has hard and fast guidelines for conventional mortgages — so much so that the Canada Mortgage and Housing Corporation has an official calculator to help you figure out both ratios.
For conventional mortgages, the maximum gross debt service ratio is 35%, and the maximum total debt service ratio is 42%.
This calculation is helpful to do ahead of time if you’re looking at a house that’s on the higher end of your potential budget — like if you’re over four times your annual income. It might be more doable if you’re otherwise debt free, as an example.
To run the numbers for real, you can connect with a lender and get pre-approved for a mortgage. That will tell you how much you’re able to borrow — although, pro tip, that can be very different from how much you can afford!
You might want to go through a brokerage, like Homewise, which can connect you with dozens of lenders at once to find you the best option.
Test 3: Just look at your budget
It’s a classic for a reason.
Beyond all of the calculators and rules of thumb you can use to get a theoretical idea of how much home you can afford, you can also look at your plain ol’ monthly budget to figure out what a “good” monthly payment would be for your life.
You already know how much money you make, and roughly what your priorities outside of housing look like. If you assume you’re not going to get a personality transplant alongside your house (unlikely) you should be able to figure out how much you can afford to spend on a mortgage and other housing expenses while still doing the stuff you love.
Once you have your ideal monthly payment, most calculators can show you how much home you can afford, based on the interest rate you expect to get.
Just remember, to get a good interest rate, you’ll need a good credit score. I check mine for free every so often on Borrowell, which can help you raise your score, too.
When in doubt, err on the low end
This is not popular advice to give, especially with housing markets being so wild, but if you’re feeling worried about how high the numbers are looking for what you could afford, pick a lower budget.
Plenty of people end up feeling stressed out because they stretched too far into a house that was right at the top of their price range, but you’ve never heard anyone complain that their house budget was “too reasonable” and they “have all this extra money for fun stuff.”
So when in doubt, do your future self a solid: err on the side of caution. After all, it’s the biggest purchase you’re ever going to make.