How much income do homebuyers need to afford a mortgage in Canada?

Buying a home is thrilling — the freedom, the space, the white picket fence — but it's also the biggest financial undertaking of your life. No wonder Canadian home buyers want an answer to that critical question: How much mortgage can I afford?

For most home buyers, the question of mortgage affordability boils down to math. Using a mortgage affordability calculator and current mortgage rates, prospective home shoppers can crunch the numbers to determine what's affordable. But it's just a start. To really understand how much mortgage you can afford, buyers need to understand the factors lenders consider when qualifying a mortgage application.

To help, here is an overview of the seven most common factors that impact how much mortgage you can get. Plus, Money.ca offers seven steps to help Canadian home buyers improve how much mortgage they can qualify for, while helping borrowers determine how much mortgage they can realistically afford.

A guide to mortgage affordability in Canada

A lender will examine at least six factors when you apply for a mortgage. These factors determine if you qualify for a mortgage, how much the lender will offer, and at what rate and terms. To help, here's an overview of how each factor will impact the mortgage affordability question.

Income needed for a mortgage in Canada

Want a loan? You'll need to prove that you can repay it, which means showing you earn an income.

Since housing costs can vary dramatically from city to city (and even neighbourhood to neighbourhood), the income requirements to qualify for a mortgage can vary significantly. So, how much you earn isn't as important as whether or not you can afford to make mortgage payments based on your earnings. Lenders just want to see that you earn enough income to make mortgage payments.

In order to make this assessment, lenders will use two ratios: Gross Debt Service (GDS) ratio and Total Debt Service (TDS) ratio.

What percentage of your income should your mortgage be?

There's a golden rule that you shouldn't spend more than 30% of your income on housing costs. That rule exists, in part, because of these two affordability ratios used by lenders to qualify home buyers for a mortgage.

• Gross Debt Service (GDS) Ratio: No more than 32% of your gross annual income should be spent on housing costs, including mortgage payments, property taxes, heating, and maintenance fees.
• Total Debt Service (TDS) Ratio: No more than 40% of your gross annual income should be used to pay housing costs, credit card balances, personal loans and other forms of debt.

Down payment: How much money have you saved?

In Canada, buyers must provide a minimum down payment of at least 5% of the home's purchase price. However, the minimum down payment can change. For instance, if you purchase a second property, such as a cottage or an investment property, the minimum down payment is 20%. This is also the minimum down payment if you are purchasing any property valued at $1 million or more. For more, read the Money.ca guide on how much to put down on a house.

Lenders consider the size of your down payment when determining what mortgage you can afford. A larger down payment generally increases the chance of qualifying for a larger mortgage.

Mortgage insurance and its impact on how big a mortgage you can get

In Canada if you do not have a 20% down payment, you'll need to pay for mortgage default insurance. Mortgage lenders are legally required to purchase this insurance — and pass on the cost to the borrower. This insurance protects the lender should you default on your mortgage payments.

In most cases, the cost of mortgage default insurance — commonly called CMHC fees — is added to the overall mortgage loan. Adding extra fees and costs to the home loan requires you to qualify for a larger mortgage. To illustrate, consider the following (note: does not reflect additional costs such as tax, legal fees, etc.):

Scenario 1:

• Purchase Price: $500,000
• Down Payment: 20% ($100,000)
• CMHC Fees: $0
• Amount Borrowed: $400,000

Scenario 2:

• Purchase Price: $500,000
• Down Payment: 5% ($25,000)
• CMHC Fees: $19,000 (approx)
• Amount Borrowed: $494,000

While the purchase price did not change, the amount a buyer had to qualify for changed. As a result, the cost of mortgage default insurance can impact how much mortgage you qualify for and whether or not you get approved for a home loan.

Debt-to-income ratio

Another ratio lenders use to assess how much mortgage you can afford is the debt-to-income ratio (DTI).

• DTI = Total monthly debt payments/Gross monthly income

Let's say you earn $4,000 monthly and spend $350 on car loan repayments. You plan to buy a home, and, using an affordable mortgage calculator, you anticipate a mortgage payment of $2,500. This puts your DTI at 71.25%.

Unfortunately, for most lenders, this DTI ratio is way too high.

Lenders typically want to see a DTI ratio close to 30% — although borrowers with DTIs closer to 50% can still find regulated lenders with competitive mortgage loans.

Amortization: How long it takes to repay the home loan

The amortization period is the amount of time you commit to repaying your mortgage. In Canada, the most common amortization period is 25 years, although anyone applying for a mortgage can adjust this time frame from as low as five years to more than 25 years.

From an affordability perspective, a longer amortization means lower monthly payments but more of your earnings is spent on interest.

Your credit score

Are you a responsible shopper who pays their bills on time and doesn't accumulate debt? Your credit score is a three-digit number calculated based on your shopping, spending and credit history. Your credit score gives lenders insight into how responsible you are as a borrower. Borrowers with higher credit scores typically get larger loans and lower mortgage rates.

7 steps to improve how much mortgage you qualify for

If you want to buy property and are worried that you won't qualify for the mortgage you require, there are steps you can take to improve your chances. Not all of these steps are easy, but taken individually or together, each step can improve your mortgage qualification based on lender criteria.

Step 1: Show a steady income

Mortgage lenders examine your income when determining whether to approve your mortgage application. While it's important to show how much you earn, it's also critical to show the stability of these earnings.

Showing regular, stable income is key to mortgage affordability. Consistent income that shows a paper trail — such as T4s provided by your employer — is a strong indicator to a lender that you regularly earn enough to repay any debt you may assume.

For self-employed individuals, showing a regular income means providing your tax notice of assessment (NOAs) for as many years as possible. However, for most lenders, a minimum of two years is required.

For those looking to maximize their mortgage affordability, getting a pay raise at least three months before applying for a mortgage can help. More earnings will shift your debt ratios — and gives the lender more confidence that you can repay the mortgage loan.

Step 2: Improve your credit score

Your credit score is critical when applying for any type of credit, including a mortgage loan. The better your credit score, the stronger the possibility of getting approved for a mortgage and getting the lowest rates at the best terms.

In Canada, most lenders only consider a mortgage application if your credit score exceeds 660. Sometimes, borrowers with credit scores between 600 and 660 can find B-Lenders or private mortgage lenders, but these loans will come with higher interest rates and other less favourable terms.

To start, be sure you review your credit history and credit score as soon as you start considering a home purchase. Many banks offer free services to check your credit history, or you look for independent companies that offer these services. Another option is to request a free credit history report from TransUnion Canada and Equifax Canada. Each Canadian can get a free credit report at least once per year.

If your credit score isn't in the excellent range, consider taking steps to improve your credit. For instance:

• Don't close lines of credit or credit card accounts.
• Be sure to pay all bills on time, even if you don't pay the balance in full.
• Pay down debt (more on this below).

For a full list of steps, read the Money.ca guide on improving your credit score.

Step 3: Pay off debts

Your mortgage lender will look closely at your debt-to-income ratio to determine how much debt you can handle — and how much mortgage you can afford. The more money you owe to other lenders — this includes car loans, student loans, credit cards, and lines of credit, among others — the less you will have to repay a mortgage loan. If you want to get pre-approved for a larger mortgage, start to repay other debts. The lower your debt-to-income ratio — the less you owe, compared to the amount you earn — typically translates to being approved for a larger mortgage loan.

Step 4: Talk to a mortgage broker

Getting the lowest mortgage rate will also help increase the amount of home loan you can afford. To get the best rates, consider comparison shopping. Talk to an independent mortgage broker and ask about the features that will help you repay the mortgage loan faster and with lower interest costs.

While comparison shopping for mortgage rates is often cited as one of the most critical mortgage application tasks, Jesse Abrams, CEO of Homewise, a fully licensed brokerage that offers a one-stop digital property ownership platform, is still surprised at how many home buyers only talk to their current bank. "When a home buyer doesn't take the time to shop the market, it's the financial equivalent to losing money."

By working with an independent mortgage broker, borrowers get a chance to shop the market with just one phone call. "As an independent mortgage brokerage, we are lender-agnostic," explains Abrams. "That means we are not concerned or influenced by the lender's marketing presence. Instead, we focus on finding the best rates and terms for borrowers."

Step 5: Boost your down payment

One of the most important factors when it comes to qualifying for a mortgage is how much of your own money you plan to invest as a down payment. In Canada, every property purchase will require a minimum cash down payment that ranges from 5% to 20% of the purchase price, minimum.

In most circumstances, a larger down payment translates into a better chance of being approved for a mortgage and the potential for approval on a larger home loan amount.

Step 6: Find a co-signor or guarantor

In very expensive cities, such as Toronto or Vancouver, saving up a big enough down payment can feel daunting. One option is to find a co-signor or guarantor to increase your chance of being approved for a mortgage and to increase the amount of home you can afford.

A co-signor is an individual who agrees to add their consumer information to the mortgage application. This is beneficial if the co-signor has very low debt ratios — in other words, they owe little compared to the value of the assets owned or income earned. The benefit is that the mortgage application will use both the primary applicant's debt ratios, as well as the co-signor's debt ratios to determine mortgage affordability. The potential downside is that the co-signor is responsible for paying back the mortgage loan should you default on the payments.

Like a co-signor, a guarantor agrees to repay the loan should you default, but their credit information is not used in the mortgage application and approval.

Step 7: Increase your amortization

One way to make a mortgage loan more affordable is to increase the overall amortization. Loans with longer amortization periods require smaller monthly payments because the amount of time allocated to repaying the loan is longer. However, longer amortization periods will mean paying more in interest charges — sometimes tens of thousands more.

While increasing your amortization can certainly make a mortgage more affordable, this option should only be taken if other options are not available.

How do lenders decide how much mortgage I can afford?

Lenders will consider your credit score, your earnings, your current debts and your history as a responsible consumer.

Just remember, there's a difference between "How big of a mortgage can I get?" and "How big of a mortgage can I afford?" Just because a lender will give you a big sack of money doesn't mean you can afford to take on this debt. Keep in mind lenders do not consider living costs when making their assessment. That means daycare or pet care costs, out-of-pocket medical expenses, vacations and groceries are not part of a lender's affordability equations. To prevent ending up house-rich and cash-poor, be sure to review your budget, look for ways to cut costs and really assess how much you and your family can afford.

How to make a mortgage more affordable

No matter how good you look as a borrower, your mortgage will seriously drain your finances. Here are four options to help make a mortgage more affordable:

Look for rebates and incentives

First-time Canadian home buyers can find land transfer tax rebates as well as apply for the federal government's First Time Home Buyer's rebate. Other rebates may be available, so check with your mortgage broker. Another option is to take advantage of rebates, such as energy efficiency rebates, when renovating your home. Again, talk to your mortgage broker or your real estate agent to learn about these programs.

Extend the amortization

By giving yourself more time to pay off your mortgage, you won't have to pay nearly as much each month. You will end up paying a lot more in interest in the long run, but your payments will be more manageable while you deal with other expenses.

Get a lower rate

Shop around and get interest rate quotes from many different lenders because even a fraction of a percentage point can save you buckets of money month after month.

Refinance

Refinancing replaces your current mortgage with a new mortgage — so get a new mortgage rate, term and, potentially, a new amortization schedule. The drawback is that most people refinance in order to assume more expensive debt. The advantage is that reducing expensive debt allows you to use more of your earnings to repay the principal debt, which further reduces the amount of interest paid and, eventually, gets you out of debt faster.

Bottom line

Knowing what you can afford before you enter the preapproval process is very important. Just because you can be preapproved for a specific amount doesn't mean that your personal budget will support that amount – you likely have expenses that are not reflected in a credit report. Take the time to hash out your monthly fixed and variable expenses and determine how much you'll need to set aside above and beyond those primary mortgage costs.