As imposing as it looks, you’re better to save 20% of the purchase price for your down payment on a home than the bare minimum of 5% down.When you choose a down payment of under 20%, the Canadian Mortgage and Housing Corporation (CMHC) will require that you pay Mortgage Default Insurance. While you can include the price of the insurance premium in your mortgage, this insurance is a costly additional expense that isn’t paying down your mortgage. Let’s look at actual CMHC calculations in the next section.
Down Payment Guidelines
In Canada, the CMHC is the main mortgage insurance provider. Let’s look at their basic guidelines for purchase of a single-family home.
Homes valued at $500,000 or less are easier to finance, as you can buy them with a 5% down payment. If the house price is $400,000, the 5% down payment would be $20,000. However, if your down payment is less than 20% you are required to buy mortgage default insurance.
Homes valued under $1 Million have a two-step process to determine your down payment. The rules for homes under $500,000 still apply, you must have 5% on the first $500,000. You must have 10% of the value over $500,000.
If the home purchased was $800,000, then you’ll need 10% of the $300,000 purchase price over the first $500,000. Meaning $30,000 for that additional value and $25,000 for the base amount of $500,000. Completing this example; you’ll need $55,000 as your minimum down payment.
Homes valued over $1 Million require the biggest down payment, it’s an easy calculation at a flat 20%. On a $1,000,000 home, it is $200,000. How big of a step up is that from the previous example? Let’s backtrack, that home worth $800,000 requires a down payment of only $55,000. While you might prefer only having to save the lesser amount, you’ll have a larger mortgage to pay off. If you are looking for homes at these values, you will breathe easier having $200,000 as a down payment than $55,000.
Keep in perspective that these are the CMHC guidelines. Let’s take a closer look at what Mortgage Default Insurance is and how it might impact your down payment decision.
What is Mortgage Default Insurance?
CMHC Mortgage Default Insurance is a requirement for home buyers who’ve made a down payment of less than 20%. If you think it’s easier to decide to purchase a home under $500,000, and only need a 5% down payment, think twice. You are now faced with purchasing mortgage default insurance, it is calculated at a rate of 4% of your total home value. The insurance can be paid along with your mortgage in equal installments. You’ll be required to carry the Mortgage Default Insurance until you’ve paid off 20% of the value of the mortgage.
Should you aim to have more than a minimum down payment?
It is always to your advantage to make a larger down payment. The 20% threshold is the ideal minimum amount to aim for regardless of the price of your home. Be aware before you purchase your home, you’ll have other expenses such as closing costs. These additional expenses are due at the time of purchase. Keep these in mind and maybe consider buying a more affordable home, so that you can put 20% down. After all, you do still have to pay your mortgage.
It would be a mistake to ignore the wisdom of people who think that Canada’s housing market is “due for a correction”. Their point of view is that housing price increases have happened consistently and Canadian real estate seems over-valued. If the market corrects and home prices drop 10% and you’ve only put 5% down, you suddenly have no equity in your home and possibly owe more for the mortgage than the home is worth. Clearly, you don’t want to be exposed to this possibility, having 5% down, is not a position of strength.
You’ve made your down payment, now what about the mortgage?
Easily an article in its own right; the question, what is a mortgage is worth exploring here. Your mortgage is a legal document that identifies the terms, such as the repayment schedule and your mortgage’s interest rate. A mortgage typically runs for 3-5 years and is renewed at the end of its term. The full amount owed on your home is amortized on a series of mortgages over 15 to 30 years.
The terms of the mortgage are worked out by your lending institution based on your personal financial situation with your total debt and debt servicing ratio being among the important determining factors.
Are there other concerns to consider when saving the down payment?
You’ve got the down payment saved. Of course, you’ve been checking the listings to see what homes are available where you want to live. You have ideas of what your dream home will look like. You find one and you actually put in an offer! The trouble is you’re not alone, many others are looking too, the market is competitive! When the “dream home” goes on the market you are not going to be the only person putting in an offer. In fact sellers know this and time putting their home on the market so that offers will come in fast and furious, creating a bidding war!
Bidding wars can spell trouble for you in a few ways if you only have a minimum down payment for the original list price of the home. You can simply be priced out if you can’t meet the new market price of the home, you are back to square one. Or possibly worse, you realize bidding wars are common and you may have to reset your starting point on home prices and look at properties that may seem less desirable. An additional problem, “Cash is King” when it comes to purchasing a home, the higher the cash portion of your offer is on a home, the more favourable it is to the seller.
Are my family members or relatives able to help with my down payment?
Rising home prices mean rising down payments. In response, first-time home buyers often look to their parents to contribute to the down payment. Most lenders are aware of this trend and require that the gift come from an immediate family member (parent, grandparent, child, sibling or legal guardian) not extended family (aunts and uncles). You must tell your lender you’ve been given a gift; it’s bank fraud to say that a loan was a gift. Keep your records, some lenders will ask that you provide a “mortgage gift letter” signed by all parties involved.
Can you build a down payment by building equity in a condo or starter home?
Does it make sense to buy a condo or home that you think will build equity and have it help you build a down payment for your more ideal home?
Unfortunately, this thinking is fraught with problems. Let’s shut this door with three solid reasons.
Equity – there is no guarantee your home is going to go up in equity to the extent you want it to, to help you buy your dream home in a few years.
Timing the market – if you are intending to buy in the same city you live in now, the trajectory of house prices in that market will impact most homes. Even if you were fortunate and gained the maximum equity on your property, the dream home has probably gone up in price and remains out of reach.
Selling and fees – Even in a hot market, count on it being next to impossible that you can watch your dream home go on the market, list yours at the same time, sell it and be in a position to make a competitive offer on the dream property. You are counting on too many stars to align and work in your favour at one time.
Final Thoughts on Accumulating Your Down Payment
It may seem difficult when all you can see are fast rising house prices. All you feel is that you are being left out and falling behind in your goal to own a home. However, it is to your advantage to save in order to accumulate a down payment of 20% of your future home. After all it’s better to get a home you can keep and enjoy than being stretched financially or at the whim of the market correction.