The column's goal is to level up your financial knowledge and help you avoid common pitfalls and mistakes along the way. Although money management sometimes seems like an intricate task, it doesn't have to be. The advice here is common sense and simple to follow. The first step to a better financial future starts here, and it's never too late to begin.
The Best Mortgage Advice I’ve Ever Given: Don’t Buy That Car
As a mortgage agent, I’m often asked ‘What is the best mortgage advice I’ve ever given?’. Though for me the answer is easy, for others, it’s a bit difficult to understand. After reading this article, you’ll understand why ‘Don’t buy that car’ is some of the best mortgage advice I’ve ever given.
The Importance of Buying a Home in Canada
Canadians own homes at one of the highest rates of home ownership in the world. In fact, over 68% of eligible Canadian families own their own home as of 2019 according to Trading Economics.
It may strike you as strange that this pride of home ownership doesn’t translate to other developed countries. In other G7 countries like Germany, home ownership rates are close to 50%. Over the past ten years, this rate has continued to decrease as prices rise and international incomes stagnate.
With Canada’s ability to provide homeownership opportunities to many, it’s not surprising that the possibility of buying a first home brings many new Canadians to our shores.
Buying Your First Home
If you’re thinking about buying your first home in Canada, there are a few steps you need to take. One of the first, and most important, steps is to pre-qualify yourself for a mortgage. This process helps you gain a better understanding of your personal financial situation with a mortgage agent.
During this process, you’ll discuss your income, outstanding debts, savings and credit. One of the most important parts of this process will be your outstanding debts. In fact, debts are one of the largest limiting factors for most Canadians looking to buy their first home.
How Debt Keeps You From Buying a Home
If you’ve never owned a home before, pay attention. Qualifying for a mortgage is a long (and sometimes stressful) process. Along with your down payment and credit, you qualify for a mortgage by determining your mortgage capacity.
Mortgage capacity is the amount of debt payment your income can sustain – at least according to the mortgage lender. Mortgage lenders use simple formulas called Gross Debt Service and Total Debt Service to determine your ‘mortgage capacity’.
Simply put, these ratios total up the expense of homeownership and all your outstanding debts and divide them by your income. Most mortgage lenders will allow you to carry a total of 44% of your income in mortgage payment, property taxes, housing expenses and outstanding debt payments.
And this is the key… ‘outstanding debt payments’. Read on to learn why.
The Basic Math Explanation
Do you remember grade 6 math class where you learned about fractions? Of course not, me neither. But I dug up a few textbooks to help me out.
There are two parts of a mathematical fraction: numerator and denominator. The numerator is the top part of the fraction. The denominator is the bottom part of the fraction. The top part has far more power than the bottom part which you’ll see very shortly.
So let’s take a look at the fraction one quarter: ¼. The bottom part of this fraction is the denominator or in our case, your income. The top part is your monthly mortgage payment, taxes, housing costs and outstanding debt payment. Currently, your ‘Total Debt Service is 25% or you’re spending 25% of your pre-tax income on housing costs and debt payments.
If we increase your income by 1 from $4 to $5, your total debt service ratio becomes ⅕ or 20%. This represents a decrease of 5%.
But, if we increase your debt payments by 1 from $1 to $2, your total debt service ratio becomes 2/4 or 50%. This represents an increase of 25% or a relative increase of 100% of debt service.
Best Mortgage Advice: So What Does This Advice Have to Do With Cars?
You’ve seen the ads. Own this car with $0 down for only $180*/biweekly.
The price of cars has skyrocketed over the last couple of decades. To sell these higher sale prices (for a piece of metal that transports you from one point to another), car manufacturers have collaborated with finance companies to trick you into making poor financial decisions.
Yet, a car is a depreciating asset. The vehicle decreases in value every day you own it. Buying a car with a loan means that each month, you are making a payment on the original value, even though the car is now worth less than it was the day before.
If you’re thinking about buying your first home, there is something important about that biweekly car payment. That new car may only cost $25,000, with bi-weekly payments of ‘only’ $185. But that payment actually calculates as a $400 monthly payment ($185 x 26 ➗12 = $400.83). That $400 payment (remember: top half of the fraction) erases approximately $100,000 of home buying power!
If you think a condo is small… a car is smaller. Buying that car before you buy your first home can have a devastating impact on your buying power, especially here in the Durham Region. If you are a first time home buyer, don’t buy that car. It’s the best mortgage advice I can give you.
About the Author
Adam Stapley is a mortgage agent with Pineapple Financial and author of the personal finance blog CanadianFinanceGuide.ca. He is intensely passionate about helping Canadians build wealth through the power of real estate. Many of the articles in this column come from Adam's experience assisting Canadians to understand and shape their personal finances. Pineapple Financial Lic #12830 CanadianFinanceGuide.ca firstname.lastname@example.org