Mortgage loan

Don't rely on rent as a guideline
Many first-time home buyers make the mistake of assuming they can afford monthly mortgage payments as big as their current rent payments. And while it makes a certain amount of sense, that calculation overlooks some major factors.

Once you've decided to forego your renting ways and start paying off own mortgage instead of someone else's, the big question you must ask yourself is how much house can you afford?

Or, more to the point, how big a mortgage can you afford?

It's a deceptively easy question. After all, you can afford however much your bank or private lender qualifies you for, right? They run your financial information and credit history through so many tests that they know best when it comes to figuring out the magic number, right?

Wrong. When it comes to how much house you can afford, you are the expert. So, before you sign up for the maximum mortgage you qualify for, which may be outside your comfort level, consider the following advice culled from recent home buyers on how to determine what you can afford.

"I often thought a safe monthly mortgage payment would be roughly equivalent to our rent," says Alex Beckett, of Toronto, who bought his first house three years ago.

"Unfortunately, property taxes and all those other ownership-related costs can add up to about the equivalent of three or more months of rent a year in Toronto."

As a renter, you never have to worry about paying extra for property taxes, which are incorporated into your rent. But for homeowners, they can easily cost between a few hundred and a few thousand dollars a year depending on where you live.

If your current rent also includes the cost of utilities, such as gas and hydro, you'll also have to figure those expenses into the monthly costs of owning a home. Most experts also recommend keeping money aside for emergency repairs, since homeowners can't call the landlord when something breaks.

You'll also want to figure in the cost of mortgage loan insurance, especially if you have a high-ratio mortgage. So, there are many new costs to consider that mean your current rent payments may not be a good guideline to follow.

"If your current rent approximates your comfort level, I think you should aim a little lower for a monthly mortgage payment," says Beckett.

There is a more precise rule of thumb for determining how big a mortgage you can afford-two, in fact. You need to know your total monthly debt load and your total monthly housing costs to figure out an affordable maximum mortgage payment.

Keep your debts around 40 percent
When Heather Keam, of Burford, Ont., was house shopping last year, she and her husband calculated how much they could afford by looking at their monthly income.

"The way we decided how much we could afford was based on our pay cheques," says Keam. "We did not want our mortgage payments to be more than 40 percent of one pay cheque."

She says sticking to that target was especially important because they were looking for a fixer-upper they could renovate themselves and knew they'd need to invest money in right away.

Keam and her husband were right on track with the experts' advice. As a general rule of thumb, the Canada Housing and Mortgage Corporation (CMHC) uses two guidelines for home buyers who put down less than 25 percent of the home's purchase price and so need a high-ratio mortgage.

The first concerns debt. Your maximum monthly debt load, also known as your total debt service (TDS), should not exceed 40 percent of your gross monthly income. In other words, the combined amount you pay in housing costs, car loans, personal loans and credit card debt shouldn't be more than 40 percent of your pretax income.

To calculate your current TDS, divide your monthly debts by your monthly pre-tax income and multiply by 100. To determine what lenders will consider your maximum allowable debt, multiply your gross annual salary by 0.40 and then divide by 12.

Cap your housing expenses at 32 percent
The other guideline concerns your housing expenses. Your maximum monthly home-related expenses-or gross debt service (GDS)-should not exceed 32 percent of your gross monthly household income.

That means your monthly mortgage payment, property taxes, insurance payments and heating costs shouldn't be more than 32 percent of your monthly pre-tax income.

To calculate your current GDS, divide your total monthly housing expenses by your gross monthly income and multiply by 100. To determine what lenders will consider your maximum allowable housing expenses, multiply your gross annual income by 0.32 and then divide by 12.

So, for example, if you have a gross annual household income of $45,000, your maximum allowable monthly mortgage payment-including the cost of heating-would be $1,200. Your maximum allowable debt load would be $1,500.

Keep in mind these guidelines are for high-ratio mortgages. Lenders will be more flexible for home buyers with larger down payments and conventional mortgages.

Think about the future
Beckett says home buyers would do well to consider their future carefully before choosing a mortgage. Because big life changes can spell big trouble when it comes to making your payments.

"Any couple planning to have kids should consider what kind of payment they could make with one of them on leave for a year," he says. "The benefits are much better than they used to be, but a lot of the employment insurance benefits get clawed back if your annual income exceeds a certain amount. That can be a very unpleasant surprise."

So, instead of taking the maximum mortgage for which you qualify, it might make more sense to settle for something a bit cheaper in case you expect to generate less household income in the future.