Borrowing capacity, everything you need to know
In the real estate field, access to real estate ownership is generally synonymous with a mortgage loan from a bank or any other financial organization. However, it is essential to know your borrowing capacity with your bank in order to adjust the personal contribution of the project and avoid overindebtedness. Équipe Caron, Multi-Prêt Hypothèques’ mortgage brokerage firm, invites you to discover in detail the notion of borrowing capacity and its importance for obtaining a real estate loan.
What is borrowing capacity?
One of the first steps in home ownership is to determine how much the investor can borrow as a mortgage. The borrowing capacity is the minimum cost that you can afford to pay for a property and the mortgage that goes with it. Borrowing capacity is based on income, monthly expenses and costs related to home ownership. It is an important step before applying for a mortgage pre-approval and allows you to know the rate at which you are eligible to make your real estate investment.
Assessing your ability to purchase a property also helps you find a property in the price range that fits your budget. One of the easiest ways to do this is to contact a mortgage broker. Simulation of borrowing capacity, rate negotiation, administrative procedures… This professional will accompany you throughout the process.
The down payment
The down payment is one of the parameters that can vary the duration of a real estate loan or its maximum amount. At Équipe Caron, we help you understand its importance and determine the ideal personal contribution for your borrowing profile!
How to identify the amount of the initial investment?
Anyone wishing to take out a mortgage in Canada must make a minimum contribution equivalent to 5% of the total value of the property to be acquired. The following table provides an estimate of the down payment required to take out a mortgage loan to finance the purchase of a home.
|Value of the property||Minimum down payment (5%)||Down payment to avoid CMHC mortgage insurance (20%)|
|40 000 $||2 000 $||8 000 $|
|200 000 $||10 000 $||40 000 $|
|400 000 $||20 000 $||80 000 $|
|500 000 $||25 000 $||100 000 $|
With a down payment of 20% or more, you can skip CMHC mortgage insurance and reduce your total mortgage by several dollars. Use an online calculator or contact a mortgage broker to determine your down payment amount.
How does it affect borrowing capacity?
One of the elements considered by the lender when calculating borrowing capacity is the down payment. With a down payment higher than the minimum required, your mortgage payments are lower. Since monthly payments are considered debt, thisincreases your borrowing capacity with your bank. With a reduced mortgage, it will take you less time to pay off your mortgage. The interest you pay decreases significantly over time, allowing you to build equity in your home more quickly.
Conditions for CMHC insurance
Mortgage loan insurance protects the lender in the event that you are unable to meet your mortgage payments. To be eligible for the Canada Mortgage and Housing Corporation (CMHC) offer, you must meet several criteria. As of July 1, 2020, you must have:
- a total debt service ratio lower than 42,
- a gross debt service ratio of less than 35,
- a credit rating of 680 or higher.
To purchase CMHC insurance, make sure you are not borrowing money for your down payment. Contact an online broker and take advantage of their expertise to build your file, optimize your loan financing or reduce your monthly payment.
Understanding your expenses, debts and salary
When calculating a home loan, the creditor limits the applicant’s ability to borrow to monthly payments equal to 33% of their income. The idea is to allow borrowers to have enough money to meet their daily expenses after each payment is made. This is known as the living allowance. Expenses include groceries, outings, gas and vehicle maintenance. This category also includes transfer fees, notary fees, appraisal fees, inspection fees, and property and school taxes.
The debts cover the monthly repayment of outstanding loans, monthly rent, alimony and any other recurring expenses. The amount obtained is then deducted from the income to determine the amount left to live on! Salary is one of the sources of income used to calculate the debt capacity. It is added to retirement pensions, property income, income from regular financial investments, industrial and commercial profits (BIC) and non commercial and agricultural profits.
To understand the role of expenses, debts and salary in the bank’s ability to borrow, you need to consider the concept of debt ratio. It compares the expenses of your household to your income in order to determine the percentage of resources that must be devoted to the payment of recurring expenses. You just have to use an online credit simulator to calculate it.
Ratios used by banks
The financial situation of the borrower determines the amount of real estate loan that will be granted by the bank. By contacting a broker, you can find out your debt-to-income ratio in order to effectively choose a bank or institution likely to grant you a loan. Here are the two main ratios used by these organizations.
The gross debt service ratio is the percentage of your gross annual income required to own your home. To calculate it, lenders analyze:
- your annual mortgage payments,
- your property taxes,
- your heating costs.
They also include a percentage of the condominium fees, depending on the case.
The total debt service ratio is the percentage of your gross annual income that is necessary for home ownership. However, it takes into account all your debts and loans. It is therefore based on your GDS percentage plus your outstanding debt on one or more credit cards and any other monthly payments.
The interest rate and your borrowing capacity
The interest rate is determined by the bank by looking at your credit rating. If your credit score is low, the interest rate may be higher, which may reduce your ability to borrow from your bank and increase your mortgage payments. With a credit score between 680 and 900, you have access to “A” quality creditors and the best rates for your home loans. A credit score below 600 means you’ll have to take out your loan with a “B” creditor and pay higher rates.
The use of a broker specialized in mortgage loans allows you to better prepare your credit application and to access interesting rates. Don’t wait any longer to apply for a pre-qualification and take advantage of the support of our experts!