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Mortgage madness

'hair, nails, gifts and mortgages' photo (c) 2007, woodleywonderworks - license: http://creativecommons.org/licenses/by/2.0/Even though this picture is clearly American, it was just too good to pass up and the same phenomenon is happening here too.  The amount of debt that Canadians are being approved for is astounding – and a bit ridiculous.  I came across a calculator online the other day that had the title “How much can I borrow?”  Personally, I don’t need to borrow anything right now, but I decided to put some numbers into the bank’s calculations (you know, just for kicks).  I entered a few different combinations and my jaw nearly dropped to the floor each time.  How much?!  I asked myself.  That can’t be right…

According to this calculator, a hypothetical family (let’s call them the Smiths) with an income of $60,000 will, subject to the bank’s final say and assuming they have no other debt, be approved for about $268,000 when they have a down payment of just over $14,000, making the total purchase price for the house $282,000.  The monthly payment on this mortgage, using the same calculator and a fixed rate of  3.34% is $1,317, which doesn’t sound that scary, but if we look at a very frugal budget of basics under this scenario (see below), that only leaves $708/month to cover such expenses as:  Saving for retirement & child education costs, transportation/vehicle, clothing, entertainment, household maintenance, vacation, kids’ sports activities, personal hobbies/gym memberships, gifts, and everything else.  I would say that’s a lot to ask of $708/month, since vehicle expenses can easily wipe most of that out.  Perhaps I’m missing something.  Here are the calculations:
Income 1
   30,000.00
Income 2
   30,000.00
Total
   60,000.00
     8,000.00
Net
   52,000.00
Monthly income after tax
 $  4,333.33
Property tax estimate*
        183.00
Utilities
        250.00
House insurance
          75.00
Mortgage payment
     1,317.00
Groceries/eating out
     1,000.00
Personal care (haircuts, toiletries)
        100.00
Daycare for 1 child
        700.00
Total basic expenses
 $  3,625.00
Remaining
 $     708.33
*  Google your city of residence – can vary widely

 

Perhaps the Smiths might say that they don’t spend $1,000 on groceries, and that’s great – please ask them to tell me where they shop!  These numbers are just estimates based on national averages and personal experience.  The point is that each family needs to figure out what these numbers are for them.  I know it’s not how anyone wants to spend a Friday night (even I get sick of running numbers) but it’s important to figure out how much mortgage is affordable based on realistic estimates, not arbitrary percentages.  This template may help with that process.  A family that is willing to eat cheap food and camp for vacations may be able to afford a bigger house.  On the flip side, a family that eats out all the time, stays in 5 star hotels several weeks each year may need to cut back on their mortgage load.  Otherwise, that family is going to find themselves up to their eyeballs in credit card debt in a very short period of time.

 

Once a theoretical number is calculated, or if the Smiths want to go with the bank’s estimate and skip the whole budgeting session, the next step would be to “practice” living with that payment.  Adding together the projected mortgage payment, property taxes, utilities, insurance, etc will give a total occupancy costs in a new home.  Using the numbers above for the Smiths, this would be $1,825/month (183+250+75+1317).
Let’s say the Smiths are currently paying $1,300/month to rent a 2 bedroom townhouse.  Their current utilities cost is included in that amount.

 

The difference between the old and new occupancy costs ($525 in our example) is what would be set aside in order to practice living with the new payments.  An automated transfer of $525/month would go from the Smiths’ chequing account into a separate savings account.  Once this has been done for 3-12 months, then a reality check can be done.  Did the theoretical calculations match up to the reality of life?  As an added bonus, when the “practice” time is up, there should be a chunk of money together to add to a future down payment, cover closing costs, or maybe buy some furniture without going into credit card debt.
In a future post, we’ll look at how a change in interest rate would impact the mortgage payments.  For now, I’d like to hear what you think.  Am I the only one who thinks that a large mortgage is a bad idea?
July 28, 2012

4 responses on "Mortgage madness"

  1. Hi Leanne!
    Thanks for your blog. It is both sobering and informative. Budgeting takes time (and restraint to carry through!) but it seems well worth the effort.

    Why do you think the bank would be recommending/approving such large loans? I know they want our business and our interest payments, but is it really in their best interest to put people so far into debt? That can’t be good for anyone in the long term.

    Looking forward to hearing your thoughts.

    • Thanks for your comment. I have been pondering this over the weekend. I can’t speak on behalf of the banks because I am not one of them. However, I do think that it must come down to revenue generation. Customers who are stretched to the limit on their mortgages are going to be the customers who use their credit cards to cover things when they run a bit short, generating even more revenue for the bank. It’s the line of stretching people to the point where they can just barely pay. There are going to be losses from customers who end up not being able to pay, but it would seem that these losses are more than offset by the additional revenue generated in most circumstances.

  2. Love the idea of practicing the new payments before making the commitment!!! Unfortunately time doesn’t always permit us to do that but if anyone is even considering moving – it’s a great place to start. P.S. Are you serious that the average grocery bill is $1000 per month? I thought it was about $600.

    • Thanks for the question. This number was the hardest to nail down and is definitely not based on a scientific survey. I tried to find some recent statistics, but all I could locate online were comments here and there about how much people spend – like here: http://www.discoveryfinance.com/average-monthly-household-grocery-bill-canada.html (scroll down to the bottom of the forum in the link for the discussion). Once you add in the costs of eating out, the $1,000 is probably not that far off. As with all the other numbers, the idea is to figure out what the amount actually is for each person’s circumstances. Our family of 4 spent about $1,250/month in 2011 at grocery stores, Costco, and dining out. Some personal care items are in that number, but it doesn’t include what we spent at Wal-Mart, which is where we get some of our food, and most of our cleaning supplies, toiletries, paper products, etc.

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