If you’ve been thinking about making the jump into homeownership, the first question you must ask is can you afford it? While $500,000 may get you a four bedroom house and half an acre of land in the Atlantic provinces, here in Toronto you’re likely limited to the condo market. So how much income is needed for a $500K mortgage on a condo?
HOW MUCH MORTGAGE CAN I AFFORD?
The first step to starting your home buying journey is to get a mortgage pre-approval. This is where your mortgage lender will look at where you stand financially to help give you an idea of how much mortgage you can afford and at what interest rate.
What they do is look at your income, your monthly expenses, what debt you may have, how much you have available for your down payment, as well as any other registered and non-registered savings you may have. They use this to calculate your debt-to-income ratios which helps them determine what you can afford.
However, your mortgage pre-approval will generally tell you the maximum mortgage you can afford but it doesn’t guarantee that you’ll get that amount. We’ll elaborate on qualifying for a mortgage later on.
CALCULATING YOUR MORTGAGE AFFORDABILITY
Calculating Your Gross Debt Service Ratio
To help you better understand the process, let’s have a closer look at how they calculate what you can afford. First, they need to calculate your Gross Debt Service (GDS) Ratio. This is done by evaluating your total monthly housing expenses against your monthly income. Your housing costs include:
- Mortgage payments
- Property taxes (2019 rate is 0.614770%)
- Heating expenses
- Half of your condo fees (if applicable)
When you add up your monthly housing expenses they should not exceed 32% of your gross income. This is how you calculate your GDS Ratio:
Annual Income ÷ 12 = Monthly Income
Monthly Income x 0.32 = Maximum Gross Debt Service
Calculating Your Total Debt Service Ratio
The next step is to account for any debts you have. This includes things like:
- student loans
- lines of credit
- car payments
- credit card payments
- child or spousal support payments
Whatever your total debt amount is, the amount should not exceed 40% of your gross income. This is how you calculate your Debt Service Ratio:
Monthly Income x 0.4 = Total Debt Service
THE STRESS TEST
The other thing to be mindful of when calculating your mortgage affordability is the Stress Test. What you can perhaps afford and what you qualify for under the government’s Stress Test are different.
Under the Stress Test guidelines, homebuyers must qualify for a mortgage at a rate of 5.19% (recently dropped from 5.34% in July 2019) or 2% higher than the negotiated rate, whichever is larger. The point of the Stress Test is to ensure you’d still be able to afford your mortgage payments should interest rates rise.
When you use the Mortgage Affordability Calculator, take your own stress test by entering the stress test rate of 5.19%.
HOW MUCH INCOME IS NEEDED FOR 500K MORTGAGE?
Given what we know above, let’s see how much you need to make to buy a $500K home.
In this example, let’s suppose you are putting the minimum down payment of 5% or $25,000. Because you have less than 20% down you’ll need to pay CMHC insurance. In this case the CMHC insurance adds an extra $19,000 to your mortgage for a total mortgage of $494,000.
Inevitably, you will have to pass the stress test when applying for a mortgage with any major lender. So first, let’s see how much income is needed to qualify for a $500K mortgage under the stress test.
Income Needed for 500K Mortgage Under the Stress Test
Let’s determine the Gross Debt Service (GDS) for a $500,000 condo using the mortgage stress test rate of 5.19% over 25 year amortization. Your household expenses break down like this:
- Property tax $256/month ((500,000 x 0.0061477) ÷ 12)
- Heating $60/month
- Half condo fees $200/month
- Mortgage payments $2,927/month
With your monthly household expenses amounting to $3,443 this means the minimum income needed for 500K mortgage under the Stress Test is $130,000 per year. This could also be two salaries of $65,000 per year.
$130,000 ÷ 12 = $10,833
$10,833 x 0.32 = $3,447
Expenses $3,443 < $3,447 GDS
Don’t forget about any debts, keeping in mind they should not exceed 40% of your monthly household income.
So while the above is how the bank will approach determining what you can afford, below is closer to the income one actually needs to afford a 500K mortgage.
Income Needed to Afford 500K Mortgage
Using the same example above, let’s determine how much income is needed for a 500K mortgage at a more typical rate of, say, 3.5%. All of your household expenses would be the same with the exception of your monthly mortgage payment which would drop to $2,466 for a total of $2,982 in monthly expenses.
In this scenario, the minimum income needed for that $500,000 condo is $113,000 or two salaries of $56,500 per year.
113,000 ÷ 12 = $9,417
$9,417 x 0.32 = $3,013
Expenses $2,982 < $3,013 GDS
Keep in mind, an income of $113,000 per year is the minimum salary needed to afford a $500K mortgage. If this is where you fall financially, you’ll want to look at condos for sale that are below this price range to ensure you aren’t over-extended.
There are other expenses to be mindful of when it comes to owning a home. You’ll also need to budget for closing costs and try to put some portion of your monthly income into an emergency fund.
INCREASING YOUR DOWN PAYMENT CAN AFFORD YOU MORE
If you are able to increase your down payment to 20% you won’t have to pay mortgage default insurance (CMHC insurance) and your monthly payments will decrease allowing you to afford more. There are other ways to increase your down payment that we discuss in our Step-by-Step Guide to Saving for a Down Payment.
Ways you can increase your down payment:
- Using the Home Buyers Plan, which allows first-time home buyers to loan themselves funds from their RRSPs
- Using funds from your Tax-Free Savings Account
- Getting a gifted downpayment from the bank of Mom & Dad
Be sure to use our Mortgage Affordability Calculator along with the Gross Debt and Total Debt Service equations from above to help you with your budget. When you’re ready, book a call with us to discuss your unique financial situation so we can take you one step closer to homeownership!