There are certain lending rules that banks are expected to follow when they approve someone for a mortgage.
In Canada, the lending rules are…
1) No more than 32% of our gross income can go towards housing related expenses like mortgage, heating, property tax, etc..
2) No more than 40% of our gross income can to towards making payments for all our debts
Mortgage brokers and banks have these rules to protect themselves from risky borrowers. They use it as a standard to evaluate potential clients across the country. But we should not be relying on these guidelines to determine how much house we should buy. What really matters when deciding the size of our mortgage is looking at our complete financial situation and figuring out how a home fits into our long term financial plan. All that means is taking some time to look over our income, expenses, and future goals. We don’t need a detailed financial strategy or analyze every penny. We just have to be realistic.
Consider the 2 different households below.
The Dubois family lives in Quebec, has 2 children, a stay at home mom, 2 large dogs, and a husband who makes $100,000 a year with no pension plan. After income tax, the Dubois family only takes home about $67,000 for all their living expenses. According the lending guidelines, this family can probably be approved for a $400,000 mortgage. But in reality they would be house poor if they bought that kind of home and they wouldn’t be able to save enough to meet their retirement goals. Poor Dubois.
On the other hand the Johnson couple lives in Alberta, don’t plan to have any kids or pets, both have stable jobs making $50,000 a year each, with defined benefit pension plans. Based on the same lending rules, they also qualify for a $400,000 mortgage. But unlike the Dubois, this couple takes home $80,000 of combined disposable income after taxes. And with presumably lower expenses than a family of four, it should be much easier for Mr. and Mrs. Johnson to finance that same mortgage.
By painting everyone with the same brush, these lending rules just aren’t very practical. That’s why they should be viewed as guidelines only. Banks are not in the business of looking out for our best financial interests. That’s why it’s up to us to plan for our own families. Instead of asking right from the start “This is my current income, how much can I borrow?..” we should instead be thinking “Here’s my entire financial situation including a savings plan. This is where I want to be a few years from now. What is the appropriate mortgage I should be taking on?” Once we know this we can then find out if our interests are within the mortgage lending rules 😀
The good news is some banks are willing to bend the rules a little bit. When I bought my apartment in 2009, 37% of my gross income was going towards housing expenses, which is over the 32% limit. I just had to explain to them how despite my high ratio, I can still save over $1,000 a month because my other living expenses are relatively low. But without making a budget and financial plan first I wouldn’t have gotten them to make an exception for me Back then I was making about $40,000 a year. Just goes to show, Vancouver real estate is not too expensive and almost anyone who has a job can afford to buy a home here, as long as they take the necessary steps.