Getting approved for a mortgage and purchasing property are significant milestones in Canadian life. With rising home prices nationwide, many prospective buyers wonder how much home they can realistically afford. Calculating your mortgage affordability provides critical insight into your maximum purchasing power.
This extensive guide examines what goes into determining mortgage affordability in Canada for 2024. We’ll explore all the key factors lenders assess when approving borrowers and offer tips for improving affordability. Read on to learn what home price range could be within your reach.
What Is Mortgage Affordability?
Mortgage affordability refers to your ability to pay mortgage debt based on your financial situation. It determines the maximum amount you can borrow from a mortgage lender to purchase a home in Canada.
The higher your mortgage affordability, the more expensive a property you can qualify to buy. Improved affordability expands your options in Canada’s competitive housing market.
It’s essential to accurately estimate your affordability before shopping for homes. Otherwise, you risk having your heart set on a price range that’s out of reach for your budget and borrowing capacity.
Why Calculate Mortgage Affordability in Canada?
Pre-planning your affordability provides three key advantages:
- Know Your Maximum Borrowing Power
Affordability calculations reveal the upper limit of what you can safely borrow. This prevents disappointment from finding dream homes you can’t finance.
- Set a Realistic Budget
Overestimating affordability leads buyers to stay within their means. Understanding your limits lets you set a wise budget for monthly payments.
- Factor in the Down Payment & Closing Costs
Mortgage principal isn’t your only expense. Affordability estimates account for mandatory down payments and closing costs.
Consulting a mortgage affordability calculator before meeting with lenders gives you an excellent perspective on your price range. However, pre-approval is necessary for a binding assessment.
How Mortgage Affordability is Determined in Canada?
Many variables affect how much mortgage you can qualify for in Canada. Lenders scrutinize your application based on the following:
Mortgage Rates
The mortgage interest rate you are offered is considered the most significant factor that impacts affordability. Higher rates diminish affordability, while lower rates reduce your principal and interest payments, allowing you to qualify for a higher loan amount.
Fixed-rate mortgages generally have higher rates than variable mortgages. According to a CMHC report, in 2024 and 2025, an estimated 2.2 million mortgages will be facing interest rate shock, representing 45% of all outstanding mortgages in Canada.
(Source: https://www.cmhc-schl.gc.ca/blog/2023/rising-rates-homeowners-greatest-shocks-lie-ahead)
As a practical example, for a $500,000 mortgage with a five-year fixed-rate term and 25-year amortization, an increase in the interest rate from 2.5% to 5% could lead to a $600 monthly payment increase.
Down Payment
Canada requires a minimum down payment of 5% to 20% on homes over $500,000. Your down payment savings significantly impact the mortgage principal and, thus, affordability. Putting less than 20% down also means mandatory mortgage insurance, which adds costs.
Amortization Period
The amortization period refers to the total time it takes to pay off a mortgage loan. The longer the amortization, the lower your monthly payments. However, it comes with higher total interest costs over the life of the mortgage.
Shorter terms mean higher payments, but greater equity builds up faster, resulting in long-term interest savings.
Income Level and Stability
Lenders want a stable income history to ensure you can make payments. Multiple years at one job look better than switching jobs often.
Salaried income may be more reliable than self-employment income, as it’s easier to verify. Some lenders specialize in assisting self-employed borrowers. Lenders benchmark your earnings against national averages. Higher incomes above these medians improve mortgage affordability.
Credit Score
A credit score is a three-digit number, generally between 300 and 900, indicating your creditworthiness and likelihood of repaying debts. Lower credit scores below 680 make approval difficult and lead to higher mortgage rates, reducing affordability.
Mortgage Stress Test
Since 2018, all Canadian mortgages must pass the mortgage stress test. This means qualifying at an interest rate higher than what your lender offers. Stress test rates are:
- Bank of Canada 5-year benchmark rate (currently 5.25%)
- Or lender’s rate + 2% (whichever is greater)
So, if offered 3% interest, you must qualify at 5% for the stress test. This protects you if rates rise but reduces maximum affordability.
Debt Service Ratios
Your debt service ratios (GDS and TDS) compare debt costs against income:
- Gross Debt Service Ratio (GDS): Monthly housing costs ÷ Monthly income
- Total Debt Service Ratio (TDS): Total monthly debt costs ÷ Monthly income
Most lenders limit GDS to 39% and TDS to 44%. If your debt service ratios exceed these limits, you won’t qualify for that mortgage. Debt service ratios directly impact affordability approvals.
Pre-Qualification and Pre-Approval
Online pre-qualification tools give quick affordability estimates. However, formal pre-approval involves document verification and hard credit checks for firm approval.
Pre-approval requires more work but provide guaranteed mortgage offers, which gives certainty when placing bids. Get pre-qualified first, then obtain pre-approval later in the home-buying process.
Mortgage affordability combines your financial profile with proven lending formulas and mandates.
Mortgage Default Insurance
Mortgage Default Insurance, required for down payments under 20%, is added to the principal, increasing monthly costs. It’s only available for residential homes priced under $1,000,000.
Typical insurance premiums range from 2.4% – 4% of the mortgage amount. This impacts first-time buyers the most.
Other Expenses
Closing costs, moving fees, property taxes, utilities and maintenance must also be budgeted for in ownership costs. These reduce the amount you can devote to housing payments.
Maximum Mortgage Affordability
Lenders approve mortgages up to amounts that keep key ratios within permitted limits. This establishes your maximum borrowing capacity.
You can estimate it yourself by following two steps:
1. Calculate Down Payment Affordability
Use the minimum down payment formulas shared earlier to determine the maximum home price your current savings support.
- If the down payment is $25,000 or less
Maximum Affordability = Down Payment ÷ 5%
For example, if your down payment is $20,000, your maximum purchase price is $400,000
- If the down payment is more than $25,000
Maximum Affordability = (Down Payment – $25,000) ÷ 10% + $500,000
For example, with a $60,000 down payment, the maximum price you could afford is ($60,000 – $25,000) ÷ 10% + $500,000 = $850,000
(Source: https://www.ratehub.ca/mortgage-affordability-calculator)
2. Calculate GDS & TDS Affordability
Tabulate your monthly housing costs, income, and existing debts. Increase hypothetical mortgage amounts until GDS hits 39% and TDS hits 44%. That’s your maximum approval amount.
However, lenders also consider your credit score, income stability, assets, and additional recurring costs. So, your actual maximum mortgage may be lower than these calculations.
It’s wise to stay within reasonable GDS and TDS limits to manage overall expenses; just because you qualify for the maximum mortgage means you can spend less.
Improve Mortgage Affordability in Canada
If your initial affordability is lower than hoped for, several strategies can help optimize it:
- Save a Larger Down Payment: Increasing your down payment percentage unlocks higher maximum mortgages and offers better rates.
- Pay Down Existing Debts: Reducing debt load lowers your TDS ratio for affordability. Pay off credit cards and loans.
- Shop Mortgage Rates & Use a Broker: Compare rates across multiple lenders and negotiate with a broker for the lowest rate. This directly increases your buying power.
- Lengthen Amortization Period: Longer mortgages (up to 30 years) reduce monthly costs but increase the total interest paid over time.
- Increase Your Income: A higher stable income directly raises affordability capacity. Consider improving your career earnings.
- Get a Co-signer: Adding a cosigner combines your income with higher qualifications. But they become liable for the mortgage if you default.
Consulting a mortgage broker provides experienced guidance on the best strategies for your situation. Now, let’s examine the calculation of maximum affordability.
Special Considerations for First-Time Home Buyers
First-time purchasers have additional affordability challenges to overcome, but specialized programs can help:
The First-Time Home Buyer Incentive provides shared equity mortgages with lower monthly costs. By qualifying at lower purchase prices, you improve your affordability.
The Home Buyers Plan allows you to withdraw up to $35,000 from a Registered Retirement Saving Plan (RRSP) for your down payment without tax penalties. This helps savers boost their down payments quickly.
Getting pre-approved is highly recommended for first-timers. This provides certainty when making an offer in competitive markets.
Budget carefully for ownership costs beyond your mortgage, like maintenance and closing fees. The First Home Savings Account helps buyers under 40 save for these expenses in a tax-advantaged way.
Read more: First-Time Home Buyers Programs
Ongoing Changes Impacting Mortgage Affordability
Canada’s housing market experiences frequent developments that influence mortgage affordability:
- The mortgage stress test rate rises and falls with the Bank of Canada’s trends. Higher stress test rates reduce maximum approvals.
- CMHC briefly tightened maximum debt ratio requirements in 2020 before reversing these changes in 2021 due to limited impact and loss of market share.
- Rising home prices across Canadian real estate markets have outpaced incomes, progressively diminishing affordability, especially for first-time home buyers.
It is recommended that you regularly review mortgage rates, housing prices, debt ratios, and affordability to stay informed and appropriately time your entry into the market.
Key Takeaways: Mortgage Affordability in Canada
- Mortgage affordability determines your maximum borrowing capacity based on financial factors such as income, debts, credit, and down payment savings.
- Mandated minimum down payments, maximum debt ratios, mortgage loan insurance requirements and the stress test limit how much lenders will approve you for.
- Improving affordability is possible through strategies such as debt reduction, improved income, larger down payments, lower rates, and longer amortization periods.
- Special programs assist first-time home buyers, but budgeting properly for all ownership costs remains critical.
- Ongoing market trends around interest rates, stress testing rules, and home prices all influence mortgage affordability.
Get pre-qualified online, then speak with an advisor or broker about pre-approval. This provides clear insight into the optimal home price range for your unique financial situation.
Buying property is a significant financial commitment. Thus, it is important to accurately estimating your affordability before meeting with lenders prevents disappointment.
The experts at Best Mortgage Online can help you feel fully confident in your mortgage affordability potential. Our advisors empower your journey to home ownership by taking the stress out of financing. With proper planning, research and professional mortgage advice, you can turn the dream of home ownership in Canada into a reality!
FAQs
How is mortgage affordability calculated in Canada?
Mortgage affordability is determined based on your income, debts, credit score, down payment amount, and debt service ratios like GDS and TDS. Lenders use proven formulas to calculate the maximum you can borrow.
What credit score do I need for the best mortgage rates in Canada?
A credit score above 760 will qualify you for the lowest mortgage rates in Canada. Anything below 680 will be challenging to get approved.
How much down payment do I need for a mortgage in Canada?
On mortgages under $500,000, you need a minimum 5% down payment. Above that, down payments rise to 10% or 20%, depending on the purchase price.
What debt ratio limits are used to determine mortgage affordability?
Lenders limit your GDS (housing costs) to 39% of your income and TDS (total debts) to 44% to ensure you aren't overextended.
How can I increase my mortgage affordability in Canada?
Getting a better credit score, saving a larger down payment, having a cosigner, paying down debts, shopping mortgage rates, and increasing your income can all improve affordability.
Does getting pre-approved increase mortgage affordability?
Pre-approval can maximize affordability by having a lender formally approve you for a specific borrowing amount after assessing your financial documents.
How do rising interest rates affect mortgage affordability in Canada?
Higher mortgage rates mean higher monthly principal and interest costs, reducing the amount lenders approve you for.
How is mortgage affordability different for first-time home buyers?
First-time buyers often have lower incomes, credit scores, and down payments saved, which results in lower affordability unless they utilize special programs.
What are the best places in Canada for mortgage affordability?
Smaller cities and rural areas generally have the best affordability. Major markets like Toronto and Vancouver are the least affordable by average income.