With the current high real estate prices, saving up for a down payment can be a real challenge. House prices have appreciated to more than $450,000 on average, implying buyers making the standard down payment of 20% will need to put down $90,000 to get into the housing market. Even the 5% minimum down payment adds up to a significant $22,500, which does not include mortgage default insurance that can cost over $15,000 for an average-priced home. Add this to the real estate deposit and closing costs such as legal fees and land transfer taxes, and you understand why half of the adults aged 34 years and below who have not achieved the milestone of homeownership blame the long time needed to save.
When it comes to sources of down payments for buyers, the rules are relatively simple. Typically, lenders need you to pay a minimum of 5% of the price of the home with your own money. You can meet this requirement by borrowing from your RRSP or a secured line of credit like Home Equity Line of Credit (HELOC). Some lenders allow you to use other resources, such as an unsecured line of credit only after you have met the minimum 5% (i.e., when you obtain 5% of the home price, you can borrow from alternative sources to add to the down payment). If you are carrying debt, don’t despair. Fortunately, the debt won’t necessarily prevent you from getting a mortgage approved. Additionally, lenders won’t consider the source of the saved funds provided you can give proof of the funds being in your bank account for a period of three months when submitting the mortgage application.
Most Canadians source their down payment funds from personal savings, including TFSAs and RRSPs. With mortgage having hit record lows, it’s hard to grow your savings without taking risks. So should you borrow for a down payment? Let’s explore the advantages and disadvantages.
1. Enter the Market Faster
This is the biggest motivation for borrowing a down payment. House prices are at an all-time high, so it makes sense to borrow and move into your desired neighborhood before prices rise further to unaffordable levels.
2. Stop Throwing Money Away on Monthly Rent Payments
By becoming a homeowner, you get rid of the rent cheque for good. Assuming your home’s value doesn’t take a tumble, every dollar that goes toward principal payments increases your equity in the home.
3. Save on CMHC Insurance
If you put down less than 20% of your home’s price, you’ll need to purchase CMHC insurance (mortgage default insurance). The size of the down payment determines the mortgage insurance premium you’ll pay. The rates reduce as you pass 10, 15 and 20% marks. According to Deposit Financing’s vice president, Steven Johnston, borrowing from a HELOC or other secured sources to raise your down payment could reduce your monthly payments as well as help you save thousands on mortgage default insurance in certain situations. For more information on what you will pay depending on the situation you’re in, check out “Getting Loans For Real Estate Deposits : Deposit Financing,” an article written by Steven Johnston
In this case, if you borrow $5,000 to increase your down payment to 20%, you’ll save $7,290 on insurance and $55 on monthly payments. What’s more, you’ll reduce your interest by $1,400 over a fixed term of 5 years at 2.49%.
4. Boost Your Net Worth
If the current trend in the Canadian housing market continues, a home’s value can grow significantly quicker than the return on a savings account. For instance, prices in Vancouver have risen by 11.2% over the past year, meaning you could get an excellent return on investment in your home.
1. Less Equity, More Risk
The additional debt repayments reduce your cushion against unforeseen events such as sudden loss of a job or unexpected home repairs. Your home equity needs to be at least 20% for you to get approved for a HELOC, so you may run out of alternatives if you’re unable to cover costs with your savings.
2. Costly Repayments
If you get your down payment loan from a lending institution, the interest rate is likely to be higher than that of your mortgage. Choosing to cover the down payment with a cash back mortgage could earn you a rate considerably greater than a conventional mortgage with a fixed term rate of 5 years. As a result, you’ll pay this high rate on the outstanding mortgage balance.
3. Taking On New Debt Lowers Mortgage Affordability
One of the factors lenders consider when assessing your ability to qualify for a mortgage is your debt service ratio. A down payment loan alters this ratio and could lower your mortgage borrowing power, depending on the monthly payments you’re required to make.
4. Family Loans Can Bring About Other Issues
According to research, 28% of first-time home buyers fund their down payment using loans and gifts from family members. This can cause several problems that can affect your ability to live happily in your new house. For example, conflicts over decorations, furniture, and other expenses can strain your relationships.
Taking out a personal loan for your down payment has its pros and cons. Whether it makes sense to do so or not all depends on your comfort level and budget. If you’re sure you can cover the extra monthly payments as well as unplanned expenses, then you may consider borrowing money for the down payment. On the other hand, if you can’t comfortably make the additional payments to your bank or family member’s bank, you’re better off taking the good, old-fashioned savings route.