Budgeting

Written by Margaret Johnson | Wednesday, 18 January 2012

Shelter

The shelter expense for family budgets is one of the most misunderstood categories of all. Why? Because we are told we have total control over the choices available.

The first and second issues are inseparably linked: availability and affordability.

Availability

Where do you live?  Actually, the questions is, “What geographical location do you reside? Are you in a remote community, a large urban centre, a rural setting? These situations dictate price and availability.

In larger urban centres there may be appear to be more choices but vacancy rates determine availability as market conditions (supply and demand) affect house prices.

In other words, urban centres tend to be more complicated. Where you live may depend upon the need for schools, access to public transit or the worksite.

Now that we are finished this short summary of issues we do not fully control, we move on to affordability.

Affordability

How much is reasonable to pay rent? The traditional answer to this question is 30% of your income. That means, if you make $1,000. per month then you can afford $300.00 per month. That’s $600.00 if you make $2,000. per month.

In a place like Vancouver that sounds more like a dream world than the real world.

Affordability for housing is calculated by some financial institutions by the gross debt service and total debt service ratios.

Gross Debt Service (GDS)

CHMC sets the standard for mortgage qualification that banks and other financial institutions follow. According to their policy monthly mortgage housing costs shouldn’t exceed 32% of the family’s gross monthly income. Housing costs include monthly mortgage payments (principal and interest), property taxes and heating expenses. This is also known as PITH – principal, interest, taxes and heating.

Total Debt Service (TDS)

The entire monthly debt load should not be more than 40% of the family’s gross monthly income. Your entire monthly debt load includes the housing costs (PITH) plus all other debt payments such as car loans or leases, credit card payments and lines of credit payments. This is called your Total Debt Service (TDS) ratio.

Gross Income vs. Net Income

Sometimes the difference between gross and net income is huge. Public sector workers typically have less net income than private non-union workers. Pension contributions and other employer-employee cost-shared benefits account for the smaller take home pay. In these situations families have less net income to service their mortgage, debt and family obligations than their private sector workers with similar gross incomes. This affects the affordability for mortgages as the family pays the bills with net income not the gross.

 On the other hand private sector contract workers may not have any statutory deductions taken from their gross incomes. This leaves them vulnerable to tax liabilities, illness and other non-paid leave from their jobs which in turn affects affordability.

Gross Debt and Total Debt Service Ratios: SUMMARY

GDS and TDS ratios only marginally deal with affordability. Instead, they are used as a lending mechanism.

The nuts and bolts of survival are really up to you and me to figure out. For renters and all those who do not qualify for mortgages, available rental accommodation clicks into the picture as a factor that determines the choices.  Sadly, they are not always affordable.

People with special needs children often face higher rents to accommodate their unique issues. Pet owners may find a shortage of affordable accommodation. Families with children may also confront unfavourable rents in places that prefer a child-free environment. Many seniors face serious financial shortages or poor living conditions because of their inability to find affordable accommodation.

Affordable housing has been a long standing issue for poverty groups and community organizations helping families struggling with poverty and the vulnerable in society.

Working families are often secluded in far away suburban areas because of housing costs but then find higher travel costs including the rapid depreciation of their vehicles eating away at their financial security.

In summary, there are numerous reasons why the assorted rules of thumb like 32% or 40% of your gross income for housing do not translate well into comfortable living. In many cases they create trouble as people assume mortgage liabilities they really cannot afford. Meanwhile, renters are often stuck in high rental situations which prevent them from saving and purchasing a home.

Shelter Costs: The Final Word

Basically, the final word about housing is this. There is no final word. Like almost everything else about personal finance it all boils down to priorities, goals and objectives. For some people buying a house is the most important goal in life. All of their energy may be focused on saving, reducing all expenses to a bare minimum, eventually purchasing a home and then renting out the basement to help pay the housing costs.

Renting is a different story. It all depends on what is available and your unique personal and family circumstances.

Over my extensive career in the credit industry, I favour the old 30% of your net income rule to the question of what housing is affordable. The only problem is, based on my extensive career in credit counselling, that this is no longer a realistic expectation. The gross debt rules prevail. So, we must really watch our spending everywhere else.