Can you afford home ownership?
It’s not about skipping the avocado toast or making that latte at home — scrimping on a few simple pleasures will not make a crushing housing market more affordable.
With the Bank of Canada raising the overnight rate to 1.5 per cent this past July 11 — the fourth hike since last summer — and the average price of a home in the Greater Toronto Area sitting at around $770,000, according to the Canadian Real Estate Association, it’s never been a more challenging time for first-time homebuyers.
Make no mistake, everyone wants you to buy property. Parents, friends, bankers, brokers, real-estate agents and a general feeling of FOMO (fear of missing out) can all increase the pressure on renters and would-be buyers to make the biggest purchase of their lives without taking full stock of the financial repercussions.
To keep you from becoming house-poor by giving in to the pressure, I’ll share a little math and logic to ensure you’re making the right housing decision for you. Check your emotions at the door Do this before you buy the door. FOMO is not a solid financial strategy, so don’t let a hot real-estate market push you into buying a property.
If you have a sizable down payment, love the community, have researched the property, and plan to live in your new space for at least 10 years, chances are you can weather a few market dips and won’t be bitten in the short term by the fees and expenses associated with buying a home. Practise your mortgage Are you still saving for a down payment or wondering how a mortgage feels? Live as though you’re paying a mortgage, plus any maintenance expenses and property taxes, and save the difference over what you’re paying in rent. You’ll quickly learn how your current budget holds up before committing to a mortgage you can’t live with. Pass the mortgage stress test The income you need to pass the stress test during the mortgage application process depends on the size of your down payment. Those buying a home with 20 per cent down or more must qualify at whichever rate is higher: the actual contract rate offered, plus two percentage points, or the rate set by the Bank of Canada’s five-year mortgage benchmark. Those with down payments less than 20 per cent face just a stress test set at the five-year benchmark.
Because mortgage rates can influence housing affordability, let’s look at how the stress test can further impact purchasing power. For example, a home priced at $550,000 with 10 per cent down, at a 3.5-per-cent interest rate over 25 years, has a total monthly mortgage payment of roughly $2,500 and requires a gross income of around $105,000. Add the stress test at a five-year benchmark of 5.34 per cent, and now your gross annual income must increase by nearly $20,000 to pass.
The choice is simple, but not easy: you either continue rent- ing and save for a larger down payment or you shop for a less expensive property. Never take a lender’s word for it Lenders want you to borrow as much as you’re willing to take because their paycheque depends on it.
Many of the lending metrics used, such as the Gross Debt Service Ratio (GDS) and the Total Debt Service Ratio (TDS), test your ability to repay your debts and mortgage based on your before-tax income and fail to account for paying taxes, retirement savings or if you can afford a new roof if it leaks.
These metrics also fail to consider your lifestyle when determining your eligibility. If you have daycare costs, disabilities, illness or face job loss down the road, your lender does not have a metric to build a safety net to keep you financially secure in your house.
The lender doesn’t have to struggle with the shortfall. You do. Before accepting a lender’s offer, find a bias-free housing affordability calculator and use your net (after-tax) income to account for savings, kid costs and other real-life scenarios to determine what you can actually afford.
First-time homebuyers are the hardest hit when high housing prices are coupled with rising interest rates. To keep yourself safe, feel free to throw some avocado toast at those who are selling home ownership without accounting for all your financial needs.