How to calculate your mortgage borrowing capacity 

If you’re thinking about becoming a homeowner, you’re probably wondering how much you’ll be able to borrow to buy your dream house or condo.

Here’s everything you need to know on borrowing capacity before you start house hunting.

Factors that affect your borrowing capacity

Financial institutions consider a variety of factors when determining the maximum amount that you can put toward mortgage payments and other housing costs. However, requirements vary from lender to lender and according to the property market.

Your income

Unsurprisingly, your individual or household gross annual income (before deductions and taxes) is a good indicator of your ability to repay a big loan.

If you receive employment bonuses, be aware that they are not taken into account by all lenders and that certain exceptions may apply.

Being self-employed will also affect your borrowing capacity, and you’ll have to show that you’ve paid your taxes to the Canada Revenue Agency (CRA).

Investment income, support payments, the Canada Child Benefit, and private and government pensions are generally taken into account by lending institutions and banks. Don’t hesitate to consult a mortgage broker for guidance.

Your down payments

The higher your down payment, the less you’ll have to borrow. Thismeans that your mortgage payments will be lower and you’ll be carrying less debt and therefore, taking lessyears to reach full repayment.

A large down payment also boosts your odds of getting a mortgage with favourable interest rates and terms and could net you significant savings on your CMHC mortgage loan insurance premium.

Your debt ratio and credit history

Before agreeing to issue you a mortgage, your financial institution will calculate two debt ratios: Gross Debt Service (GDS) and Total Debt Service (TDS). These indicators will guide the broker on what is the maximum amount you can afford.

Gross debt service (GDS)

The GDS is used to assess the percentage of your annual gross income that covers your housing costs. That includes mortgage or rent payments, municipal and school taxes, heating costs, and condo fees, if applicable. For insured loans (i.e., loans with a down payment of less than 20% of the property’s value), your GDS should be between 32% and 39%.

Total debt service (TDS)

If necessary, the lender will then calculate your TDS, which is an indicator of your ability to repay your mortgage and any other debts. To calculate it, simply add your debt obligations to your housing costs, then divide it by your gross annual income. According to current government standards, your TDS must not exceed 44%, although requirements vary from lender to lender.

Your financial institution will also look at your credit report, as it reflects your spending habits and your ability to meet your financial obligations on time. A good credit score could increase your chances of getting a mortgage with favourable terms or a lower interest rate.

Interest rate

The interest rate set by the lender also has an impact on your borrowing capacity. The higher your rate, the higher your mortgage payments. It may not be ideal to reach for the maximum price for a house without considering that other costs come into play later.

Costs to consider when buying a home

Now that you know what kind of property you can afford, you might be tempted to start looking for homes near the top of your borrowing capacity. However it’s affordability should also be considered. You can use our calculator to run different monthly mortgage payment scenarios.

It’s wise to set your sights on a less expensive property to account for other costs that come with buying your home. A good rule of thumb is to budget around 1.5% of the price of your property for these expenses, like various taxes or renovation costs.

Municipal and school taxes

Even if you’re not a homeowner, you’ve probably heard of the infamous “welcome tax,” also known as a transfer tax. First-time buyers usually receive the bill three to six months after purchasing a property.
You’ll also have to pay municipal and school taxes every year. At the time of purchase, the notary will apportion the taxes for the current period between the buyer and seller.

Home Insurance

Once you purchase your home, you’ll want to make sure it’s protected. That’s where a robust home insurance policy comes in! You should expect to pay considerably more for your home insurance than your renter’s insurance.

Notary fees

In Quebec, all real estate transactions must go through a notary, and the buyer covers the bulk of the bill. You may also have to pay for things like title insurance.

How can you increase your borrowing capacity?

The higher your borrowing capacity, the greater your odds of getting a mortgage with favourable terms. Luckily, there are things you can do to increase it!

Pay down debts and reduce your financial obligations

Now you know how your debt ratio and credit history can impact your borrowing capacity. If you want to improve these metrics before you start the buying process, there are a few simple steps you can take.

For example, you could consolidate your debt, make sure you pay your bills on time, or use your credit card sparingly.
If, like many future buyers, you have student loan debt, you’ll probably need to develop a repayment strategy. Otherwise, you could be turned down for a mortgage.

Increase your down payment

A larger down payment will demonstrate your financial capacity and good spending habits, as well as reduce your total mortgage balance and payments.

Increase your income

A higher income will have a positive impact on your debt ratio, and lenders will also take your income stability into account.

Key takeaways

• Your debt ratio and credit history have an impact on your borrowing capacity.
• Avoid maxing out your borrowing capacity so you have enough funds to cover other costs associated with your home purchase.
• The higher your borrowing capacity, the better your mortgage terms.