Knowing what you can afford at the beginning of your search saves you time and disappointment later on. The following calculations outline the processes financial institutions use to determine what you can afford.

Lenders such as banks and trust companies allow you to spend approximately 30 to 35% of your gross annual income on house costs (including property taxes, heating and, if applicable, 50% condominium fees). The ratio of debt to income is referred to as the Gross Debt Service ratio or GDS

1. The first affordability rule is that you monthly housing costs shouldn't be more than 32% of your GROSS household monthly income. Housing costs include monthly mortgage principal and interest, taxes and heating expenses – known as P.I.T.H for short. If applicable this sum also includes half of monthly condominium fees and the entire annual site lease ( in the case of leasehold tenure)

Lenders add up these housing costs to determine what percentage they are of your gross monthly income. This figure is known as your Gross Debt Service (GDS) ratio. Below is a table to calculate your GDS

1. The second affordability rule is that your entire monthly debt load shouldn't be more than 40% of your gross monthly income. This includes housing costs and other debts, such as car loans and credit card payments. Lenders add up these debts to determine what percentage they are of your gross household monthly income. This figure is your Total Debt Service (TDS) Ratio.

The table below calculates your TDS ratio and to determine the monthly housing costs you can afford after making other monthly debt payments

The maximum home price that you can afford depends on a number of factors but the most important are your gross household income, your down payment and the mortgage interest rate.

This table gives you an idea of the maximum home price you can afford,

The table assumes a mortgage interest rate of 8%, average tax and heating costs in Canada , and the mortgage an average Canadian would qualify for based on a 32% debt service ratio.

For most people the hardest part of buying a home – especially the first one – is saving the necessary down payment. Many people will not have the traditional 25% of the purchase price to put down. With mortgage loan insurance, you can put as little as 5% down. Mortgage loan insurance protects the lender, and, by law, most Canadian lending institutions require it. The way it works is if the borrower defaults (fails to pay) on the mortgage, the lender is paid back by the insurer. The cost for this type of insurance is in the form of a premium and can be paid in a single lump sum or it can be added to your mortgage and included in your monthly payments

CMHC is a major provider of this type of insurance in Canada and its current loan premiums are as follows:

Don't forget that the minimum 5% down payment must come from your own sources. However if you have a good credit history and an income to support the financial obligations of homeownership, you could benefit from CMHC's Flex Down product. The Flex Down product allows homebuyers to obtain the minimum 5% down payment from virtually any source, including lender incentives and borrowed funds, provided that the source is arm's length to purchase or sale of the property.

Other restrictions to consider with the minimum 5% down payment:

• The buyer must move into a portion OR all of the home
• The borrower must qualify having a GDS of no m ore than 32% and a TDS of no more than 40% of the family income
• The CMHC insurance premium is 3.25% of the entire mortgage amount. This premium can be added to the mortgage
• The mortgage must be a minimum three-year term

The next step is to select a lender to get pre-approved. This means that the lender will look at your finances to establish the amount of mortgage you can afford. At that time, the lender will give you a written confirmation or certificate for a fixed interest rate good for a specific period of time.

A pre-approved mortgage amount makes the search for your new home much easier and less time-consuming because you have a good price range in mind.

Some of the things you will need to have with you the first time you meet with a lender are:

• Your personal information, including identification – drivers license
• a. Your proof of income:
  an up-to-date letter of employment from your current employer
• b. one of the following:
• your most recent tax year's Revenue Canada tax assessment
• current pay stubs
• your most recent year's T4 slip
• c. if you're self employed, you may be required to provide copies of three year's worth of Revenue Canada tax assessment statements
  
• Your proof of down payment can be a copy of:
• a. a GIC term deposit
• b. RRSP statements
• c. A “gift letter” or a print out of your bank account
• needed within 21 days prior to getting your keys

Before approving you for a mortgage, lenders will want to see how well you have paid your debts and bills in the past. To do this, they simply get a copy of your credit history (credit report) from a credit bureau. This provides them with the information on your financial past and use of credit. Before your lender sees your credit history, you should get a copy for yourself to make sure the information is complete and accurate. Simply contact one of the two main credit-reporting agencies (Equifax Canada Inc. or TransUnion of Canada) to get a copy of your credit report. There is often a fee for this service.

Lack of Credit History – if you have no credit history, it is important to start building one by, for example, applying for a standard credit card with good interest rates, and terms, making small purchases and paying them as soon as the bill comes in.

Fixing a Credit Report – if you have bad credit, lenders might not want to give you a mortgage loan until you can re-establish a good credit history by making debt payments regularly and on time. Most unfavourable credit information, including bankruptcy, is dropped from your credit file after seven years. If you have bad credit you may want to consider credit counseling.

Despite a poor credit history, you might still be able to get a mortgage loan if you have a relative such as a family member willing to be a guarantor or co-signer on the loan. This person must meet the lender's borrowing criteria, including good credit history, and is legally obligated to make the mortgage payments if you do not.

The lender will then do a credit bureau check in advance to check your credit and verify that there are no glitches. If your supplied information and the credit check turn out OK, you'll receive an Unconditional Pre-Approval Letter that is your guarantee of the lender's commitment and only conditional upon either an appraisal of the home that you intend to buy or CMHC/GE Capital approval.

Will you have trouble qualifying for a Mortgage?

Your calculations may show that you will have trouble meeting monthly dept payment and that you will likely have trouble getting approved for a mortgage. Here are some things you can do:

• Pay off some loans
• Save for a larger down payment
• Revise your target house price
• Meet with a credit counselor who can help you minimize your debts
• Buy your home through a rent-to-own program provided by the builder, a non-profit sponsor or government sponsor
• Find out about programs which you can help build your own home
• Ask the housing department of your municipality about any special programs available.