The amount of money you can afford to spend for a new home is determined by two factors:
Your down payment
This is the amount of money you have available from your own assets. You need a minimum of 5 per cent of the total purchase priceas a down payment. A larger down payment means lower mortgage payments or, even better, a shorter term, thereby saving thousands of dollars in interest payments. Or you may be able to buy in a higher price range, if you qualify. (Be careful, though, not to stretch your budget to the limit, and to set enough money aside to cover the other expenses of buying a home.)
First time home buyers can use their RRSPs towards a downpayment and closing costs. Under the federal government's Home Buyer's Plan, first-time buyers can borrow up to $25,000 tax-free ($50,000 for couples) from their RRSP savings.
But before you rush to empty your retirement fund, think hard. The funds must be repaid within 15 years, so not only will you be paying a mortgage, you'll also be paying off what you borrowed from yourself. Meanwhile, your retirement fund isn't growing. If you can confidently predict that your income will go up over the next 15 years, you can consider this option. If you're starting to save now, consider saving outside your RRSPs so the money is available without penalty.
Your ability to carry mortgage debt
Lenders use a simple two-step method to determine the mortgage amount that you can comfortably pay back on your income. As a rule, you can use no more that 32 per cent of gross income on monthly payments to cover principal, interest, property taxes and heating, house insurance and possibly condominium fees, or 40 per cent of gross income on all financial obligations. The latter could include car payments, credit card installments and other payments in addition to the "shelter" costs, such as a mortgage.
That's how lenders look at it. But this is your life, and you want to have one. Don't push it to the limit.
Use 30 per cent of your take-home pay for your shelter costs. That gives you the ability to save for retirement, handle the costs of another child or absorb a mortgage-rate increase. That advice comes from the non-profit Consolidated Credit Counseling Services of Canada, and organization that's seen a lot of people swamped by shelter costs.
Once your maximum monthly payment towards shelter costs has been established, it is easy to determine the size of loan you can handle, depending on interest rates and amortization periods.
Be aware of the total costs
When you calculate how much it will cost to buy a home and how much you can afford, don't forget to consider the additional costs that you may encounter. Ask your builder and the sales representative for detailed estimates, and consult with your mortgage broker and lawyer for further information, particularly on sales tax.
