How much mortgage can I afford on my income?

Before you shop for a home, it helps to know what a lender will let you borrow. The answer depends on your income, your debts and a test at a higher interest rate, not just the rate you will actually pay. This guide shows how the calculation works so you can estimate your own limit.

The short version: lenders cap your housing costs at 39% of your gross monthly income and your total debt payments at 44%, and they calculate your payment at a higher "stress test" rate.

The two ratios lenders use

Both ratios use your gross income, before tax.

The Gross Debt Service (GDS) ratio covers the cost of the home. According to CMHC, housing costs should not exceed 39% of gross household income. They include mortgage principal and interest, property taxes, heating, and 50% of any condo fees.

The Total Debt Service (TDS) ratio adds everything else you owe. Total debt payments should not exceed 44% of gross income. That means housing costs plus car loans, student loans, lines of credit and credit card payments.

Whichever limit leaves you less room is the one that applies. With no other debts, GDS is usually tighter. Once you have a car payment or a student loan, TDS often takes over. These are the standard limits for insured mortgages, and lenders set their own policies for uninsured ones.

The stress test: why the payment is higher than your real one

For most new mortgages, lenders check the ratios at a qualifying rate, which OSFI, the federal banking regulator, sets as the greater of your contract rate plus 2 percentage points or 5.25%. At a 4% contract rate the qualifying rate is 6%. At 3% it is 5.25%, because the floor applies.

The test does not change the rate you pay. It only limits how much you can borrow, and it is why an online payment calculator can suggest a bigger mortgage than a lender approves.

Step by step: working out your own limit

1. Find your gross monthly income: yearly household income before tax, divided by 12.
2. GDS limit: multiply by 0.39.
3. TDS limit: multiply by 0.44, then subtract your monthly debt payments.
4. Use the lower of the two. That is the most you can spend on housing each month for qualification.
5. Subtract property tax and heating, plus half of any condo fee.
6. What is left is the payment you can qualify for. At a 6% qualifying rate on a 25-year amortization, each $1,000 of mortgage costs about $6.40 a month, so $3,000 a month supports about $469,000.

Example: $120,000 household income, $800 a month in other debts

• Monthly income: $10,000.
• GDS limit: 39% = $3,900.
• TDS limit: 44% = $4,400, minus $800 of debts = $3,600.
• The lower figure applies: $3,600.
• Subtract $300 for property tax and $150 for heating: $3,150 is left.
• At a 4% contract rate (6% qualifying) and a 25-year amortization, that supports a mortgage of about $492,000.
• Your real payment on $492,000 at 4% would be about $2,590 a month, well below the $3,150 used to qualify.

Debts matter more than most people expect

Once TDS is the limit, each $100 of monthly debt payments lowers your maximum mortgage by about $15,600. A $600 car payment can cost you about $94,000 of borrowing power. Paying off a loan or a credit card before you apply can raise your limit more than a small raise would.

Ways to qualify for more

• Pay down or pay off debts before you apply, starting with the highest monthly payments.
• Add a co-borrower with strong income and credit. Both of you are fully responsible for the debt.
• Choose a 30-year amortization if you qualify. It lowers the qualifying payment by about 7%, but the insurance premium rises by about 0.20%.
• Increase your down payment, which lowers the mortgage you need. At 20% or more you also avoid the insurance premium.
• Look at homes or condos with lower fees. A $450 condo fee counts as $225 in your ratios.

Afford versus qualify

Qualifying means a lender will approve you. Affording means you can live comfortably with the payment. The ratios leave out food, childcare, insurance, commuting, maintenance (a common guideline is about 1% of the home's value a year) and the closing costs you pay in cash, often 1.5% to 4% of the price.

A good test is to take your real payment, add property tax, heating, insurance and maintenance, and compare the total with what you spend on housing and save today. Many people find that a payment 15% to 20% below their maximum feels much more comfortable.

Rules and lender policies can change.

Sources: CMHC: calculating GDS and TDS, OSFI: minimum qualifying rate.