Buying a home is an important decision that requires thought, planning and saving. But how much should you save? The answer to this question depends on many factors such as your income, credit rating, financial history, etc. Mortgages are usually the largest loan you will ever take out and require a good understanding of your borrowing capacity.
If you are about to buy a home and are wondering how much you can borrow for a mortgage, you’ve come to the right place. In this article, we discuss various aspects that determine how many lenders will be willing to offer you when you take out a mortgage.
What is borrowing capacity?
A person’s borrowing capacity defines the maximum amount of money that can be borrowed from a financial institution or lender. It is one of the most important criteria that lenders consider when calculating the risk of granting a loan.
Your mortgage borrowing capacity depends on several variables, such as :
- Annual or monthly income of the borrower
- Monthly expenses
- The debt ratio
- The rest to live
- The duration of the loan
- Interest rates
Borrowing capacity defines the creditworthiness of the borrower. When you get married, the borrowing capacity increases, because the incomes of the spouses are considered together.
What are the requirements for a mortgage?
In order to secure a mortgage, it is important to meet four conditions:
- Make an adequate down payment (usually a minimum of 20% of the purchase price of the property)
- Have a debt ratio of less than 30% and prove its ability to repay
- Show the value of the house to be purchased
- Have a good credit rating
These criteria are used to prove to the financial institution or lender that will grant you the mortgage that you are capable of repaying the money on time. All lenders calculate the risks involved before accepting a mortgage application.
How to calculate your borrowing capacity?
The borrowing capacity is calculated according to the debt ratio and the living expenses:
- The debt ratio is the ratio of the borrower’s regular expenses to his or her income. This ratio indicates how much money can be spent to repay the loan and whether the lender is already burdened with debt.
- The amount left to live on is the amount of money a household has after spending all its expenses. This amount offers security to lenders if it is considered sufficient.
- The monthly repayment capacity is equal to the remaining balance multiplied by 0.33 (this figure represents the acceptable threshold of the debt ratio)
You can multiply your monthly repayment capacity by the total duration (in number of months) of the loan to know your borrowing capacity. On the other hand, you should know that the value of the mortgaged property plays an important role in the calculation of this borrowing capacity.
In this case and depending on the situation, several factors may come into play:
- The down payment value
- Property taxes
- Notary fees
- Debt capacity
- The repayment period
Things to consider when determining what you can afford
Taking out a mortgage is a long-term commitment that requires careful consideration. Among the elements to take into consideration before determining which mortgage to opt for, the borrower’s income and job stability are among the most important parameters, whether the borrower has a stable administrative job or is self-employed and generates fluctuating income.
In addition to the fixed cash flow, consider daily expenses such as bills, insurance costs, debts to be repaid and taxes to be paid. These expenses usually weigh quite heavily and are a significant part of the borrower’s expenses. These items help define the terms of the loan, including the term of the contract, monthly payments and interest rates.
What is the difference between a pre-qualification and a mortgage pre-approval?
Mortgage pre-qualification is used to evaluate the approximate capacity to borrow for the purchase of a house according to different criteria (debt ratio, income of the borrower, etc.). It allows you to determine the price range and the type of property you can afford to buy. This document allows you to better target your research by demonstrating your seriousness towards sellers.
The mortgage pre-approval is used to guarantee the borrower’s ability to borrow and to protect the borrower against a possible increase in real estate market prices during a 90-day period. It is a free process and does not entail any obligation to grant the loan. Nevertheless, it offers a guarantee to lenders that your mortgage payments will be respected.
The mortgage pre-approval includes various personal information such as employment, financial situation, assets and liabilities of the borrower as well as his payment history. It allows you to demonstrate your seriousness to financial institutions and to prove to them that you are trustworthy and that they are not running any risk by borrowing money from you.
When you are pre-approved for a mortgage, you show lenders that you are a creditworthy and eligible candidate for a loan. It offers several advantages and is a more important document than pre-qualification. In addition, it guarantees you fixed interest rates for 3 months.
How much of a mortgage can I afford?
Be aware that the total amount of the mortgage is closely linked to the debt ratio, which must not exceed the 30% threshold. Beyond this threshold, financial institutions tend to refuse to grant any loan because they consider the borrower to be insolvent. It is therefore essential to verify your solvency before applying for a mortgage loan.
Furthermore, the amount of the mortgage or mortgage ratio depends on the value of the property you wish to purchase. Generally, this mortgage ratio represents approximately 50 to 80% of the value of the house to be purchased. Other expenses are also taken into account when calculating the amount of the mortgage, such as administrative costs and legal and notary fees.
How do lenders determine the amount of a mortgage?
The amount of the mortgage loan varies depending on the multiple parameters that we have mentioned earlier in this article. Lenders only take calculated risks and want to have guarantees of repayment before borrowing any money. Thus, if you have a large inheritance, good savings or if you have put money aside, this can play in your favor when calculating the loan.
Similarly, entrepreneurs who own shares in a company can use their assets to guarantee their creditworthiness to financial institutions. On the other hand, family mortgages, which combine various donations from family members, are reassuring to mortgage lenders, who tend to give their approval easily.
In addition, certain government assistance programs can give you the boost you need to increase the amount of the mortgage loan, such as the Canada Mortgage Corporation (CMHC) grant. These elements, added to the value of the property and your borrowing capacity, allow lenders to determine the mortgage amount to lend.
How do I calculate a down payment?
The down payment is the initial amount you invest from your own pocket to purchase a property. This amount depends on the purchase price of the house and represents roughly 20% of its market value. If the down payment is less than this, the borrower will need to purchase mortgage default insurance.
Looking for a mortgage?
Refinance Mortgage Consultants provide professional and personalized services to help you find the mortgage that best suits your financial situation. We know that all these calculations can be complex and that the process can seem difficult. That’s why we’re committed to making the process easier to help you buy a property.
Getting a mortgage that fits your financial goals allows you to live in the home of your dreams while enjoying the day-to-day financial stability to continue living the lifestyle you want. Our experts are available to guide you through the entire process and put you in touch with the lenders who will meet your needs.