Lately, we have been reading a lot about the grave crises of owning a home for Canadians between the ages of 25 and 45. Since prices of houses are skyrocketing relative to the sluggish growth of their incomes, owning a home for these people is becoming beyond their reach.

To help these Canadians own a home, the federal and provincial governments have been hard at work developing measures to facilitate homeownership – varying from a single detached to a garden home to a condominium in a high-rise building. A potential buyer’s choice of the type of house purchased depends, besides other personal considerations, on how much money that buyer can pay as a down payment and how much of the mortgage he/she is qualified to have.

Current affordability test

In Canada, a potential home buyer must qualify the initial two-layered test of affordability of a home: first, a buyer spends no more than 30 – 32 percent of the household’s gross income on the mortgage payment, property tax, and utilities, including heat, hydro, and water; and second, a buyer can maintain spending the same percentage of gross income if the interest rate on the mortgage were to increase by another two percentage points.

Government incentives to potential buyers and developers

To further help potential buyers in Canada, the federal government, in its latest annual budget/economic statement, announced a few new measures: first, a mortgagee can pay off the mortgage over a span of 30 years instead of the standard 25 years – in other words, increased the so-called amortization period; and second, a buyer can have mortgage insurance (to protect the lender’s money) on a home worth up to $1.5 million – raising it from the previous limit of one million dollars. To cap it all up to facilitate home ownership, the government has further removed its share of Goods and Services Tax (GST) on the purchase price of a home bought by first-time buyers. These measures were in addition to the incentives already in place that allowed a potential buyer to use funds from his/her Home Ownership Savings Plan and/or a Registered Retirement Savings Plan (RRSP). Any funds a buyer withdraws from RRSP are to be put back in the plan within ten years after buying a home.

To help developers, on the other hand, federal, provincial, and municipal governments are providing land, financial help in land development, construction costs, and rapid license approvals, besides other requirements to expedite the construction or supply of new housing units. The emphasis is on constructing multi-unit high-rise buildings or stacked dwellings (considering the scarcity of habitable land).

All such incentives for potential buyers and builders are meant to provide expeditiously a roof over the head for the younger households or those newly arrived in Canada. A household has a perfect choice to own or rent a unit. To own a unit, a household can either pay the unit’s full price or take a fixed or variable-term mortgage at a given interest rate, amortized over a conventional 25 – 30 years. And, if a household opts to rent, it signs a lease stating monthly rent and other terms and conditions of living in that unit.

Owning a home requires a significant investment and long-term legal and financial commitment. For most Canadian households, their home is their primary asset – an asset that requires a large sum of money to acquire and a good amount of income flow and savings to maintain it, i.e., paying not only for utilities and property tax but also its furnishings and equipment, insurances, repair, renovation, in/outside care, installation of security – to name a few relevant maintenance expenses that some homeowning families are not that comfortable to handle. These families may have passed the core affordability test, on or near the borderline of buying a house. However, after its possession, they will have a problem maintaining it. Such families are also termed as ‘asset rich but cash poor.’  

The unspoken part of the affordability concept

The current concept of affordability is misleading as it lacks vital components, such as a potential buyer’s net income flow, expenditure pattern, and savings to lean on or meet unexpected expenses. The current concept uses the buyer’s household gross income before income tax and other deductions and guesstimates of utilities. Since the mortgage and all other regular and unexpected expenses are paid out of the net income and savings, a potential buyer fails to see the exhaustive nature of expenses he/she would incur on the home from the household’s current financial capability. A borderline buyer is too enthused to consider the future potential expenses and sign the purchase agreement.

The outcome of this financial miscalculation

The outcome of this miscalculation is calamitous. The shortage of cash and likely no personal savings compel a household to rely more on debt, including excessive use of credit cards, line(s) of credit, if available, and other borrowings from banks and other institutions, relatives, and friends. Since this debt is in addition to the mortgage debt, a household is now heavily indebted and is obligated to make additional debt payments from its net income, leaving less to pay the regular bills and other unexpected or unplanned obligations. Over time, this home-owning household is overburdened with colossal debt and must put the house on sale or receivership.

An inability to pay this excessive debt load may cause several health issues for the borrower (s), including physical and mental stress, insomnia, and heart disease. On the personal side, it may cause disharmony in a household with a couple arguing and blaming each other for the financial mess they find themselves in. So much so, that they may eventually decide to part ways and dissolve their household unit.

The house a couple in love entered with all the pride and happiness one day now exits the house on separate ways with anger, frustration, remorse, and blaming each other – all because of their financial inability to afford a home. A couple could have avoided all such misfortune if they had taken a realistic view of the expenses involved in owning and maintaining a home, even if they had qualified for the current two-layered test of affordability.

Current affordability test

In Canada, a potential home buyer must qualify the initial two-layered test of affordability of a home: first, a buyer spends no more than 30 – 32 percent of the household’s gross income on the mortgage payment, property tax, and utilities, including heat, hydro, and water; and second, a buyer can maintain spending the same percentage of gross income if the interest rate on the mortgage were to increase by another two percentage points.

Government incentives to potential buyers and developers

To further help potential buyers in Canada, the federal government, in its latest annual budget/economic statement, announced a few new measures: first, a mortgagee can pay off the mortgage over a span of 30 years instead of the standard 25 years – in other words, increased the so-called amortization period; and second, a buyer can have mortgage insurance (to protect the lender’s money) on a home worth up to $1.5 million – raising it from the previous limit of one million dollars. To cap it all up to facilitate home ownership, the government has further removed its share of Goods and Services Tax (GST) on the purchase price of a home bought by first-time buyers. These measures were in addition to the incentives already in place that allowed a potential buyer to use funds from his/her Home Ownership Savings Plan and/or a Registered Retirement Savings Plan (RRSP). Any funds a buyer withdraws from RRSP are to be put back in the plan within ten years after buying a home.

To help developers, on the other hand, federal, provincial, and municipal governments are providing land, financial help in land development, construction costs, and rapid license approvals, besides other requirements to expedite the construction or supply of new housing units. The emphasis is on constructing multi-unit high-rise buildings or stacked dwellings (considering the scarcity of habitable land).

All such incentives for potential buyers and builders are meant to provide expeditiously a roof over the head for the younger households or those newly arrived in Canada. A household has a perfect choice to own or rent a unit. To own a unit, a household can either pay the unit’s full price or take a fixed or variable-term mortgage at a given interest rate, amortized over a conventional 25-30 years. And, if a household opts to rent, it signs a lease stating monthly rent and other terms and conditions of living in that unit.

Owning a home requires a significant investment and long-term legal and financial commitment. For most Canadian households, their home is their primary asset – an asset that requires a large sum of money to acquire and a good amount of income flow and savings to maintain it, i.e., paying not only for utilities and property tax but also its furnishings and equipment, insurances, repair, renovation, in/outside care, installation of security – to name a few relevant maintenance expenses that some homeowning families are not that comfortable to handle. These families may have passed the core affordability test, on or near the borderline of buying a house. However, after its possession, they will have a problem maintaining it. Such families are also termed as ‘asset rich but cash poor.’  

The unspoken part of the affordability concept

The current concept of affordability is misleading as it lacks vital components, such as a potential buyer’s net income flow, expenditure pattern, and savings to lean on or meet unexpected expenses. The current concept uses the buyer’s household gross income before income tax and other deductions and guesstimates of utilities. Since the mortgage and all other regular and unexpected expenses are paid out of the net income and savings, a potential buyer fails to see the exhaustive nature of expenses he/she would incur on the home from the household’s current financial capability. A borderline buyer is too enthused to consider the future potential expenses and sign the purchase agreement.

The outcome of this financial miscalculation

The outcome of this miscalculation is calamitous. The shortage of cash and likely no personal savings compel a household to rely more on debt, including excessive use of credit cards, line(s) of credit, if available, and other borrowings from banks and other institutions, relatives, and friends. Since this debt is in addition to the mortgage debt, a household is now heavily indebted and is obligated to make additional debt payments from its net income, leaving less to pay the regular bills and other unexpected or unplanned obligations. Over time, this home-owning household is overburdened with colossal debt and must put the house on sale or receivership.

An inability to pay this excessive debt load may cause several health issues for the borrower (s), including physical and mental stress, insomnia, and heart disease. On the personal side, it may cause disharmony in a household with a couple arguing and blaming each other for the financial mess they find themselves in. So much so, that they may eventually decide to part ways and dissolve their household unit.

The house a couple in love entered with all the pride and happiness one day now exits the house on separate ways with anger, frustration, remorse, and blaming each other – all because of their financial inability to afford a home. A couple could have avoided all such misfortune if they had taken a realistic view of the expenses involved in owning and maintaining a home, even if they had qualified for the current two-layered test of affordability.

Keywords: Homeownership, First-time home buyer, Affordability, Two-layered affordability test, Household gross income, Household net income, Mortgage debt, Household total debt, Household expenditure, Savings, Home maintenance expenditure, Bankruptcy, Receivership, Household disharmony.