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:
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?