I wrote in one of my previous posts that you shouldn’t overindulge. I also wrote that you should be very careful about using too much leverage when buying a home. Why are financial decisions so difficult? Why can’t everything be so easy like brushing your teeth? I’m sorry, but life is hard and financial decisions can shape your everyday life. If you are not ready for these decisions, then perhaps you are not ready to purchase a house. I’m sorry to let you down.
Many will ask, what’s the proper amount of money I should allocate towards my home? Unfortunately, there is no golden number. Factors such as where you live or how much you make will greatly influence the percentage of your take home income that needs to be allocated for shelter.
When you go to do a pre-approval for a mortgage the major banks in Canada will use the standard benchmark that no greater than 32% of you gross income should be allocated towards shelter costs. This means that if you gross $4000 a month, no more than $1280 should be allocated for shelter. This value includes mortgage or rent, utilities, maintenance fees and any taxes you may pay. Even though this is just a guideline, banks are more than willing to “stretch” you a little further and give a greater allowance. Remember the banks want to make money off you!
A recent housing affordability report issued by RBC found that on average across Canada, affordability of housing dropped and now requires 43.3% gross income for a bungalow or a staggering 48.9% of gross income for a two storey house. If we look at the big cities in Canada such as Toronto and Vancouver the percentages are even higher. 55.6% and 63.7% in Toronto. 84.2% and 87.4% in Vancouver. These staggering affordability numbers haven’t stopped the house prices from climbing higher across the country or slowed the home buying industry. Buy now or be priced out forever, right?
If you look at the above numbers it doesn’t make sense. The banks’ own guidelines suggest 32%, but these percentages are way higher in Toronto and Vancouver. The banks don’t care, they want your business. Having the percentages go up means very little to the bank as long as your first priority is to pay off your mortgage, which for many Canadians, it is.
If you are looking to buy a home, the most prudent way to look at the affordability is to look at your own finances. Forget about the numbers and the statistics that go with affordability because no one is exactly average and everyone’s situation is different. Remember that the numbers I wrote above are for gross income, this is a lot different from net income which is after taxes. So let’s look at an example:
With a monthly gross income of $4000, in Ontario your net income for the month would be $3143.84 after income taxes (CPP and EI not included). That net income amount represents 78.6% of your gross income. If we save 10% of what we make we’re down to around $2843.84. This still isn’t too bad to start with as a baseline budget. The common sense question you want to ask yourself at this point is how much are you willing to spend on shelter and how much you want to spend to maintain your standard of living? Are you fine with eating in everyday, or do you want to go out with friends more often? Is going to the movies important? Do you want to have a life?
I’m sure that most of us would prefer the latter, rather than spending all your money on housing. Remember those nasty stats? If you lived in a two story home in Toronto it said on average it would consume 63.7% of your gross income. So if you wanted to live in those posh, highly in demand neighbourhoods of Toronto and only grossed $4000, you would be out $2536. If we use the after tax number that would leave you only $607.84 in your pocket for other expenses. That doesn’t sound too appealing does it? I certainly don’t want to destroy your dreams of owning in Toronto, but reality speaks volumes and for some the suburbs are the only affordable neighbourhoods.
Let’s forget about those average numbers again and budget accordingly. Having $2843.84 to spend a month is quite a substantial amount. Perhaps finding a place where you can buy for only $1500 a month, or consider renting for that amount. Even then you would be allocating more than 32% of your gross income, but living in a large vibrant city requires some sacrifices. After $1500 in living expenses, it leaves $1343.84 to spend per month or $339.56 per week to spend on discretionary items. This is still quite a substantial amount of money. It might even leave you room to save even more than the recommended 10%. In this example you’ve set aside only 37.5% of your gross income, but came out looking pretty good. Sometimes it pays to do some homework before declaring that your life sucks.
If we look at Vancouver, well, none of it makes sense when after taxes you only have 78.9% (if you made 40k, it gets lower as you make more) of your gross income left over. Anyone that knows math knows that 78.9% is lower than both 84.2% and 87.4%. Either RBC got it all wrong, or nothing is affordable in Vancouver. Regardless, it seems that there are many millionaires in Vancouver, but none of them are having any fun.
So what can we learn? Do your own math. Figure out what is comfortable for you. Remember that you are learning to manage your own personal finances and not let the banks or personal financial advisers dictate what decisions you make. Last but not least, don’t take my advice, but learn from my advice and use your own financial skills to determine the best common sense approach that works for your own finances.