If you're a first-time home buyer, it can be very difficult to know how much mortgage is too much or too little. It’s often said that a man’s home is his castle. But what if instead of feeling like a castle, your home felt more like a prison with your mortgage as a life sentence? That’s what can happen when you make the costly mistake of buying “too much home.” When you do this, you can find yourself house rich but cash poor, with little money left over to save, let alone have fun. How do you avoid this unpleasant situation? Here’s an excerpt from my new book, Burn Your Mortgage that discusses figuring out how much house you can comfortably afford.
Don’t buy too much home
The simplest way to be mortgage-free sooner is to not take on a massive mortgage. This shouldn’t come as a big surprise. The lower your mortgage, the less time it takes to pay off.
Getting pre-approved for a mortgage tells you how much home you can afford. Just because the bank says you can spend up to $800,000 on a home, that doesn’t mean you have to. The words "up to" are key here and are what many home buyers overlook. You don’t want to spend so much on a home that it’s a drag on your finances.
No one knows your budget limits better than you
When I was house hunting, the bank said I could spend up to $500,000. That would mean taking on a mortgage of $330,000 on my own. I didn’t feel comfortable with that much debt to my name, so I set myself a maximum purchase price of $450,000. No matter what, I wouldn’t spend more than this amount, because it's not just about knowing how much home I can afford but also how much mortgage I can afford. In the end, I ended up with my dream home and spent only $425,000. If I had spent $500,000, there’s no way I could have paid off my mortgage in three years by age 30. (“Mortgage-free at 33” may have a nicer ring to it, but I’d much rather be mortgage-free at 30.)
You don't have to take the maximum mortgage load your bank offers you
When your bank tells you your maximum home purchase price, do the math and see if you’re comfortable taking on a mortgage that size. Generally, you don’t want to spend more than 37 percent (42 percent in pricey real estate markets) of your gross (before tax) monthly income on your monthly mortgage payment, property tax, carrying costs such as heating and other debts. You’re almost always better taking on a mortgage below the maximum amount you’re eligible for. This gives you financial wiggle room if you lose your job or the roof starts to leak.
Stick to your numbers
Let’s say that the most you want to spend on a home is $800,000. With a 20 percent down payment ($160,000), your mortgage will be $640,000. You and your partner can afford to pay $3,500 per month toward the mortgage (you must be lawyers). Write those three figures down on a piece of paper, fold it up and stick it in your wallet before heading to the bank. When your banker says that you can spend $1 million on your “dream home,” stick to your guns. Know that $800,000 is the most you’re willing to spend on a home, end of story.
Still not convinced?
A common argument for buying as much home as you can is that your principal residence is tax sheltered. Real estate has been on a tear in Canada over the last two decades. Since the family home is one of the last tax-sheltered investments, why wouldn’t you buy a McMansion if you can afford it? All your money may be tied up, but if you ever need it, you can tap into your equity with a HELOC. What’s not to love? Plenty.
Don't put all your eggs in one basket
Bigger isn’t always better, especially when it comes to home buying. What people seem to forget is that a bigger home comes with higher carrying costs. You’ll shell out more for property tax, heating and electricity. You’re not going to want to leave those extra rooms empty, so you’ll spend more on furniture. With your cash flow tied up, you’re not able to save for other long-term goals like retirement. Not to mention, you’re not properly diversified, since all your money is tied up in your home. (Diversification is a way to reduce risk by choosing different types of investments, for example bonds, GICs and mutual funds.)
Speak to a non-profit credit counsellor for free budgeting help
The bottom line is by buying a home you can truly afford, you won’t feel financially stressed. You can still enjoy the finer things in life, like a Starbucks latte, without feeling like a slave to your mortgage. And if you're not sure what your monthly budget is and how much your mortgage payments should be, call Credit Canada at 1.800.267.2272. One of their certified credit counsellors can go through your monthly expenses and put together a budget for you at no cost. Or if you're looking to rebuild your credit so you can finally buy your dream home, you can book a free Credit Building Counselling session with them too!
Sean Cooper is an in-demand personal finance journalist, speaker and money coach. He’s the author of the new book, Burn Your Mortgage, available now on Amazon and at Chapters, Indigo and major bookstores.