1.)    The interest rate charged on the mortgage

2.)    The amortization, or length, of the mortgage.

When it comes to lenders or banks deciding upon the amount and rate of the mortgage loan, they will certainly look into the financial background of the borrower.

Lenders are typically looking to satisfy themselves of the Three C’s of credit – Including the capacity to repay the loan, along with the credit history and the character of the individual. These factors can be determined initially by looking at the credit score, and secondly by calculating several ratios before the determination of how much credit they can grant to the borrower.

The Real Cost of A Mortgage

When one decides to buy a house, there are several payments that must be paid on time in addition to the actual mortgage payment. These other payments should always be included when we ask ourselves the question ‘How much can I borrow for a mortgage’?

Such additional payments consist of home owners insurance, property tax and home owners association fees. When these are all added to the mortgage payment, they comprise a more realistic cost of home ownership. In addition, add this to your other anticipated monthly expenses and this is one of the ways to estimate how much you can really afford when you apply for a mortgage.

Private Mortgage Insurance – PMI

This might be another expense that could alter how much mortgage we can afford. Private mortgage insurance, also known as PMI; is an additional cost that must be added if you are not able to afford 20% of the homes price paid as a down payment. In such a case, you will need to purchase private mortgage insurance in order to protect the bank’s investment in your high ratio mortgage.

Front-End Ratio

The front and ratio is the comparison between the monthly mortgage cost-which includes insurance, real estate taxes, private monthly insurance with your total monthly income. Generally mortgage costs are given to make up between 26% to 29% of your monthly income, in this case your monthly maximum repayment amount would be $840. This is another analysis you can use in answering the How much I can borrow for a mortgage question.

Back-end Ratio

When your total income is compared with your total debt payments, this is called back end ratio. This, more comprehensive, ratio includes credit card debt and college loans, and any other debt you have. It can make a total of up to 33 to 40% of your income.

For example, if your bank sets 35% as the limit, and you have a monthly income of $3000. In this case your total debt paid in a month would be $1,050. If you pay $400 as a monthly student loan, you would then have a maximum of $650 left from your income which can be used to repay the mortgage loan.

Credit Score

If you have a good credit score, the banks may increase the limit of the above ratio calculations because your history of repayment cements the bank’s faith in your credibility. Once the ration is determined, all the aforementioned characteristics and calculations help both the borrower and lender in deciding how much credit is really affordable for the borrow.

As you can see, answering the question ‘How much can I borrow for a mortgage’ is not as easy as we might think.  There are many variables that lenders take into consideration and we must fully understand those variables in order to determine how much mortgage we can really afford.  It’s just not as easy as some online mortgage calculators would have you believe!

For more information on Mortgages, check out my Mortgage Survival Guide For the First Time Homebuyer!

What’s interesting is that dopamine has also been identified by researchers in the field of neuroeconomics (which combines neuroscience, economics, and psychology to study how people make financial decisions) as the cause for imprudent, short-sighted investment decisions.

Not surprisingly, dopamine tends to be released in the brain more frequently when market volatility increases. This is precisely why it’s so important for investors to always make rational, long-term investment decisions based on facts and strategies, not emotion.

Investing Facts

With that in mind, to kick off your week I thought it would be helpful to provide you with a few market facts you might find useful:

• 2009 was the 22nd best year ever for the S&P 500 Index going back 128 years (as far back as data is available). The index however, is still 29% off its 2007 high.
• Despite rising over 30% last year, the S&P/TSX Composite Index is still about 18% below the high water mark it set in July 2007.
• Last year, the MSCI World Index rose 27% in US$ – its biggest annual gain since 2003 and proof that diversifying globally is still an important investment strategy.
• After peaking in November 2008, the VIX index – a closely watched measure of stock market volatility – fell 75% in 2009, a record annual drop.
• After an outstanding 2008, U.S. government bonds ended 2009 with their worst one-year performance in three decades. Despite this, and an improving environment for stocks, flows into mutual funds in the US are still running at five to one in favour of fixed-income assets over equity markets.

Although infomercials and investments are worlds apart, consumers and investors alike, need to make rational decisions based on facts and their long-term needs. For investors, a key success factor is having a well developed investment strategy, complete with rules in place. With a strategy, like investing in dividend growth stocks, you can turn to your stock selection strategy rather than Tony Little or Vince Offer - my personal favourite.

Slap Chop anyone?

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In addition, the market turmoil of the past two years caused new financings of commodity exploration and development projects to become next to non-existent, so these imbalances have been exacerbated.

Ultimately, the message is the supply / demand imbalance has created a recipe for longer-term commodity price strength. It appears all the ingredients are in place for this longer-term secular theme to play out.

Using oil as an example, here are some points to consider:

• If China and India per capita consumption grows to levels similar to Mexico’s current consumption, global demand would increase by over 36 million barrels per day. This would require the equivalent of three more Saudi Arabia’s to meet this demand.
• Future oil demand will come from developing countries. For example looking at global energy demand from 2005 through 2030, it is projected that OECD (Organisation for Economic Co-operation and Development) countries will show a 19% increase while Non-OECD countries will show an 85% increase.
• Supply constraints support ‘higher for longer’ prices in oil.
• Oil reserve decline rates are getting higher, and the costs of getting oil out of the ground are increasing (the oil sands being a good example of this).
• Even if large-scale investment resumed immediately there is a time lag before commodities can get to market, so this makes it very likely that we will see most commodity prices go higher in time.

An argument against commodities in the long-run requires a belief that the U.S. economy will implode, China and India will not grow, and the wealth effect caused by the growing middle classes in developing economies around the world will not occur. 

In my humble opinion, it would be a large stretch to see all of the aforementioned scenarios not play out.

 However, long-term Investors who choose to sit in perceived ‘safe’ investment like savings accounts, CDs and money market funds should realize that the historically low yields are likely going to leave their portfolio returns flat for some time.

In response to the low yield environment, it seems that some are taking innovative (albeit somewhat questionable) measures. That said, an interesting investmetn vehicle has popped up in France that gives a whole new meaning to ‘alternative investing’. It seems that investors over there are turning their attention to an age old option – cow lease contracts!

Cow Lease Contracts

The process goes something like this:

Buy a couple of cows and rent them out to professional farmers for milk production. From a cost perspective, this is a plus as it helps the farmers generate cash flow and frees up money for other necessary expenditures like buildings and machinery. This type of meat market may sound extreme but promoters of cow leasing suggest that the potential yields are 4 to 5 times that being paid on savings vehicles today.

As the herd grows, each new cow represents a new source of cash flow. New offspring cover deaths in the herd, some cows are sold off to cover maintenance costs and in particularly fertile years, the return on investment for each cow can be as high as 7%. Investors can sell the new cows for cash or continue to build up their herd to then draw a regular income at retirement.

Cow Lease Risks

Although it may sound like a nifty little investment strategy, as with all investments these cash cows are not without risk. Fluctuations on the price of meat, milk and animal feed as well as unexpected disease are just some of the considerations for cow contract investors.

While environments of change often motivate innovation (did you know that Disney, FedEx, Microsoft and Apple were founded during periods of economic recession?), discipline remains the key to long-term investment success.

As dividend growth investors, we must remain confident that we are on the right track to achieving our long-term goals. Whether those ultimate investing goals are growth or income.  It also means that we won’t need to follow the herd on the latest investment fad or have to convert our houses into cattle ranches anytime soon!

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The following are three high-level economic data points that we can use, along with our other tools, to further assist us determining our views on equity market investments.

1.) U.S. Housing

As the root of the credit crisis, healing in the U.S. housing market is a precondition for sustainable recovery. Recent data has confirmed that the worst is behind us and the residential real estate market is stabilizing.

The inventory of unsold houses while still high is heading in the right direction towards clearing and sales of existing homes have recently turned positive on a year-over-year basis. And an index which measures year-over-year price changes of houses in 20 major U.S. cities (the S&P/Case-Shiller Home Price Index) plunged 33.6% from its June 2006 peak to the April 2009 trough, but has now climbed 1.9% over the past two months.

2.) The U.S. Consumer

The resurgence of the U.S. consumer will be key to watch as recovery unfolds since consumption is 70% of the American economy. Despite the ‘hit’ that the housing crisis has exacted on their net worth, American household balance sheets are still in relatively better shape than they’ve been in the past due to the tremendous growth net worth over the last decade.

However, the process of deleveraging (winding down debt) has begun and this will impact spending patterns in the near-term.

3.) The U.S. Manufacturing

The level of manufacturing has historically followed an inverse path to the Fed funds rate but on a 6-month lagged basis – as the fed funds rate drops, six months later, manufacturing activity picks up.

However, in fall 2008, although rates declined to historically low rates, the credit crunch intensified and that typical relationship between low interest rates and increased manufacturing activity did not materialize. More recently, credit channels have opened up and the ISM (gauge of manufacturing activity) has improved, indicating the economy is finally responding to massive stimulus after a long lag.

And further improvement just yesterday with the latest ISM level better than expected at 52.9 – the first reading above 50 since January 2008 and hit the highest level since June 2007. This is further indication that while not yet normal, the economic environment is normalizing.

These are three key areas of the market to watch when assessing the high-level economic situation and it’s relationship to the stock market trends and valuations.

Of course this isn’t the be all and end all of data you should include in your due diligence, but it certainly plays a role as you calculate your risk tolerance moving forward.