Published: October 23, 2020 • Last updated: November 3, 2020 at 15:49 pm
Conventional Wisdom About Down Payments Could Cost You A Lot Of Money
“Down payments are one of the least strategized parts of home buying, and yet they can have a big impact on your total long-term cost of owning a house”, according to Rob Carrick of the Globe & Mail. “The conventional wisdom about 20-per-cent down payments is right on the money, but not if you’re set on buying in a hot market. Either jump in now or resolve to wait and save indefinitely for sanity to return.”
Rob’s assessment may be shocking to many, but the notion that most people don’t give much thought to planning their down payment is certainly true. It’s time we sat down and had a frank discussion about your down payment and how to maximize your home buying power and the opportunity for growth in home equity.
Your Down Payment: The Basics
To pay for your new home, you will put up some money (your down payment), and your mortgage lender will kick in the rest. In Canada, the minimum required down payment is five percent of the purchase price, and if your new home costs between $500,000 and $1,000,000 you must put up ten percent of that portion.
Over one million dollars, you will need at least 20% of the purchase price.
On top of that, mortgage lenders also want to see you have enough additional money on the day of closing for costs such as legal fees, land transfer tax, PST on the CMHC insurance premium, possible property tax advance payment, and things like utility hook ups and moving costs.
Typically, they will want to see an additional 1.5% of the purchase price for these unavoidable miscellaneous costs. Your actual closing costs will vary – especially they will be higher if you are not a first time buyer and you are living in Toronto.
What’s Wrong With Saving For A 20% Down Payment?
Old school thinking says you should first save up at least a 20 percent of the purchase price for a down payment before you buy.
And that can make sense if your local real estate market is stagnant. There may be no rush. And if you do have 20% or more, you can avoid the mortgage default insurance.
But in markets like Toronto, Ottawa, and Vancouver, waiting has been EXTREMELY COSTLY for many years. Prices have risen so fast that getting to the magical 20% figure could mean you pay hundreds of thousands extra for the same home, and of course that means not only a larger mortgage, but a larger down payment. The conclusion: As long as their markets remain buoyant, you are better served by fast tracking your home purchase.
What If You Don’t Have Enough For The Minimum Down Payment?
Many buyers are anxious to buy a home, but do not have as little as a five percent down payment saved up. They are frustrated being on the sidelines and watching everyone else grow their home equity.
So, with all the recent changes to mortgage rules, is it still possible to buy a home with no down payment? The answer is YES, but it isn’t easy.
Somebody has to come up with at least a 5% down payment, but it does not have to be you the borrower.
You could borrow your down payment. Mortgage agents and brokers have access to lenders who are okay with this. It’s called a Flex Down Payment mortgage. Here is Canada Guaranty’s Flex 95 Advantage program which offers a flexible down payment option for borrowers with a strong credit history.
You do have to be careful the new debt you take on does not adversely affect your debt service ratios to the point where you may no longer qualify for a mortgage. If it is from revolving credit, practically all lenders will impute a monthly payment of three percent of the balance, regardless of the actual arrangement you have.
Warning – the truth is that it is very hard to qualify under this sort of program. In all other respects, your application must be super strong. If you have excellent credit, stable employment, and a healthy income, buying a home without having actually saved up for your down payment may work for you.
With the cost of home ownership so high these days, many young people turn to their relatives for help with their first down payment. This is fine with the lenders, as long as the money is a pure gift, not a loan, and you both sign a letter to this effect.
Organize Your Documents
It’s also important to understand that your mortgage lender must verify your down payment going back 3 months typically. All bank account and investment accounts contributing toward the down payment will have to be provided. All large transactions (which are not payroll related) will have to be explained and cross referenced with further documentation. It’s therefore a good idea to consolidate your savings into one or two places well in advance of requiring a mortgage, to save you time and grief later.
- In stable real estate markets, saving as much as 20% down payment makes sense to avoid Mortgage Default Insurance.
- In frothy markets with fast-rising house prices, saving for the minimum 5% will get you on the equity train faster and will likely mean a much smaller mortgage and smaller down payment needed versus waiting.
- For extremely well-qualified (high credit score, good income) buyers, it’s possible to buy with even less than 5%, but most should not count on this, and it’s risky.
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