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Renting vs. Buying a House: How to Know What you Can Afford

Posted by in Money
2
Oct 2015

When you plan to purchase a home, it is important to know what you can afford.

Renting Or Buying A House

In Canada, you need a minimum down payment of 5% to purchase a house. Some lenders will offer you a mortgage without a down payment, however if you have not been able to save money for a down payment, it could be an indication that you cannot afford to own a home. You need to be able to afford the monthly mortgage payments that have to be paid every month without any excuses.

If you purchase a home that is out of your price range, it’s very likely that you are going to struggle to make the monthly payments.

Buying a home out of your affordability range can put you in a foreclosure situation when you fail to make your monthly payments. The mistake that people make is to think that they can afford to pay a mortgage because they can pay that amount in rent every month.

Unfortunately, your rent does not equate to a mortgage payment because the trust cost of home ownership is 40% higher than your mortgage payment. There are extras including utilities, insurance, maintenance and repairs, strata fees and property taxes on top of your normal monthly mortgage payment.

Most people do not think about this simple fact. What they do instead is purchase a home in the upper part of their affordability range. Purchasing out of your affordability range can pose many problems because you are not leaving savings or a cushion when expenses run out of control.

Making a Savings Plan

A better idea is to take an amount equal to 40% of the rent that you currently pay and deposit it into a separate account on the first of every month. Once you have done this for six months, you can reflect on that experience and determine if you struggled to make that extra payment or if you were able to make it work. Were you able to make the payment on time or was it a struggle? If you were successful, then you are probably ready to purchase a home.

It does not matter how much you think you can afford for a mortgage payment because the bank will only lend you a certain amount. Banks will let you spend around 32% of your income for a mortgage payment and the added heating costs and property taxes. This amount is your Gross Debt Service Ratio.

Your Total Debt Service Ratio cannot be more than 40% of your total income. In other words, your debt payments cannot be more than 40% of your total household income. If your TDSR is close to 40%, then it will be difficult for you to make your mortgage payments.

When you buy a home, you should own it after 25 years, having paid off your mortgage. Stick to a budget so that you are on schedule to pay your home off. If you continue to rely on credit cards and credit lines you are not getting ahead, you are just prolonging your debt indefinitely. After your mortgage has been paid off you may be able to afford to retire because you are living “rent free”.

If you need a better idea of what you can afford, most banks have a calculator on their website that helps you to determine a price range that suits your income.

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