July 7, 2020
Canada’s national housing agency anticipates a 9-18% dip in housing prices following the COVID-19 lockdown and expects it to remain low at least until 2022. This offers a good chance if you are planning to buy your first home. However, do you have enough money to make such a move? Are you aware of the requirements for the minimum mortgage down payment in Canada?
Let’s find out how down payment in Canada works, the amount you need to pay upfront, the legitimate sources to borrow, the rules regarding the same, if your savings can help, and the latest changes made by the Canada Mortgage and Housing Corporation.
The Minimum Down Payment in Canada:
A mortgage down payment is a share you are required to pay on your own while buying a property with a loan. It is calculated at a certain percentage of the purchase price of a property and the amount is paid upfront. The lender pays the rest amount to complete the transaction and you have to repay the loan amount over a period of time with interest rate agreed. For example, when financing a mortgage, you are required to pay at least 5% as a down payment. You can put as much down as you feel comfortable with. The more you put down the less your total loan payment is.
Rules are in place seeking a minimum down payment in Canada for all mortgage loans. However, it varies depending on the price of a house you plan to buy.
- If the price agreed is less than $500,000, you have to pay 5% of it – $25,000 – as the minimum down payment.
- When it is between $500,000 and $999,999, you have to pay 5% for the first $500,000 and 10% up to $999,999. So if spending $650,000 you would need $40,000 ($25,000) first $500,000 and $15,000 for the remaining $150,000. Confusing I know.
- A housing price beyond $1,000,000 requires a down payment of 20%.
Why Do you Ned a Down Payment in Canada?
Lenders consider the down payment as a type of security in a mortgage deal. Borrowers investing their money are less likely to default on loans. This also allows banks to recover the maximum possible amount in case of a default and minimize losses.
Down payment in Canada is also viewed as a tool to discipline borrowers and make them ready for homeownership. Budgeting to pay the down payment is a good sign of responsible financial management. If you can not pay the down payment, you are unlikely to manage expenses associated with the homeownership and hold on to your first investment.
It is a must for homebuyers to purchase CMHC Mortgage Insurance when the down payment is less than 20% of the transaction. The aim is to protect the lender from any loan default. Those paying a down payment above 20% can have insurance but it is optional. You have to pay a percentage of the quoted price as the premium, which varies based on the size of the amount paid upfront. The higher is your down payment, the lower is the insurance premium.
Apart from the insurance premium, the size of the down payment is directly linked to your amortization. The bigger down payment lowers the loan obligation and you have to pay less every month and over the entire spread.
Down payment in Canada is also a benchmark of your affordability. The minimum you pay decides the maximum you can afford. For example, the upfront payment is 5% or $25,000. Are you able to get a loan of $475,000? Factoring into your income and current debts, you can calculate if you are able to loan the amount and buy your own home. If not eligible for that much loan, you need to up the down payment. If you are eligible for a $450,000 loan, you must arrange for a $50,000 down payment, or earn more income. You have other options, but this is just to give you an example.
Putting a 20% down payment increases your amortization and reduces your payment. This means with less than 20% down payment, your monthly payment is going to be higher and with a lower interest rate. With a 20% down payment, your mortgage payment will be lower despite a higher interest rate. I know it is a little confusing, use our mortgage calculator to help figure this out for yourselves. Calculate how much you need to pay for your dream home.
What You Can Use for Down Payment in Canada:
You can rely on different sources to come up with a down payment. These include:
- Chequing and savings accounts
- Registered Retirement Savings Plan (RRSP)
- Tax-free savings account created for investments
- Mutual funds, stock bonds
- Selling of assets
- Gifts from immediate family members
Saving for the big occasion is the conventional way of funding a down payment. When you don’t have adequate cash on hand, you may seek financial assistance from family members, relatives, or friends. They can also gift you money. However, the law prohibits taking gifts from anyone, such as a seller or real estate agent, who will be benefited from any such transaction. To check for acceptable sources of down payment in Canada and learn how you can borrow it, check out our blog.
Can’t Save Enough Faster As Inflation Outpaces Your Savings
Saving money to pay for a down payment is an age-old practice. However, in the face of rising inflation today, it is impossible to accumulate enough savings to make a 20% down payment in a short period of time. Inflation in Canada is a major issue straining the finances of many households. The prices of goods and services are rising faster than the inflation rate. At a time when many are without jobs and energy prices remain low, galloping food prices post the largest year-on-year increase. A simple visit to a vet for your pet’s checkup cost you $200. When households across the country remain cautious in their spending behavior as they struggle to adjust to rising goods and services prices, saving a large sum for a down payment is something beyond their consideration.
Even if you reduce your expenses and compromise on your hobbies, comfort, lifestyle, and even food to save money every month, considering the present inflation and job scenario, this is going to be hard to get enough money for a down payment. Let’s see how.
According to TradingEconomics, personal savings in Canada will be around 3% until 2021 and may go up to 5% in 2022.
An analysis of income according to OECD data puts $1,277 average household savings in 2020. If we look at the historical figures, the savings rate in Canada is 7.61%. At an income of $60,000 a year, this helps save $4,566. Let’s take your savings capability anywhere between $1,000 to $4,000. You need at least 6 to 25 years to save adequate money to pay a 5% down payment in Canada on a $500,000 house. Not only is the time on the wrong side, but the rapid appreciation in housing prices may also deny you a preferred home after a few years. You have to sell out more then, almost 20% higher after 6-8 years.
But if you are using alternatives to saving money year after year, you are able to get a house now and protect yourself from paying more after a few years.
Can I Borrow To Fund My Down Payment?
Loans are an option if that can help you save money in the long term. An increase in down payment saves you on both higher monthly payments as well as CMHC premiums. So here is a quick hack on how to borrow 100% of the money for your home.
You can actually borrow from your RRSPs and use that money for your down payment in Canada. Under the RRSP Home Buyers’ Plan approved by the federal government, first-time homebuyers can take a loan up to $35,000 per person to pay as the down payment. A couple, thus, can borrow $70,000. This means you can pay a 5-10% down payment on buying a house of $500,000 and arrange the rest through a mortgage loan.
However, this RRSP borrowing is a loan and you have to repay it within 15 years of the withdrawal. The funds are subject to tax if you are unable to pay them back within 15 years.
Take an investment loan to invest in the RRSPs and max out as much as you can. Then withdraw that money and apply it towards your down payment in Canada. Boom, you now accelerated your home buying process. This is the simplest way of explaining the process however it is not that simple and you should speak with me first before doing something like this. You want to ensure you can qualify for a mortgage before implementing this strategy. Book a call with me here to see how much you qualify for.
However, it is important to consider the cost of withdrawing from your RRSP. These are meant for retirement savings and get more interest rates than savings accounts. You need to check the benefits vis-à-vis appreciation in housing prices. The RRSP loan also has some eligibility riders. You must be the first-time homebuyer and the house should be your principal home. The fund to be withdrawn must be deposited for a minimum of 90 days. I have a whole bunch more to share with you about this topic and simply cannot fit it into this email. So I encourage you to speak with me directly about your options or check out our blog post on this topic.
The 90-Day Rule for Down Payments:
The Money Laundering and Terrorist Act requires homebuyers to present proof of down payment sources. You can collect money from a combination of multiple sources but have to provide a 90-day printed history of all such bank accounts with the evidence of ownership. It calls for proof of source for any deposit over $1,000.
Similarly, you need to submit the 90-day history of RRSP and the evidence of money withdrawn. If the money is gifted, again it is a 3-month account statement and a declaration of the gift. In the case of assets sold, you need to furnish the bank account, where the money is deposited, and the proof of selling it or sales contract.
If you are a first-time homebuyer, moving money around between accounts is going to make things harder for you. What I mean by this, is you need to show a paper trail of which accounts the down payment is being withdrawn from. So if you, like most people have funds in multiple accounts and would require a 90-day history of each of those accounts. If you try to consolidate the funds into one account to make the process easier, it often makes it harder and frustrating. But don’t worry because with our system we can actually collect the down payment documents on your behalf, making the application process seamless with minimal documents from you.
The recent changes by the Canada Mortgage and Housing Corporation are expected to affect first-time home buyers. With effect from July 1, borrowing to fund their down payment in Canada won’t be accepted for default insurance purposes. The 80-point increase in the required credit scores and the lowering of the debt service ratio also hit their overall purchasing power. However, these effects can be managed to empower home buyers.
We are going to discuss these and other things related to home buyers at our First Time Home Buyer Webinar scheduled for July 11. We will be teaching everything inside these emails and helping you qualify for a mortgage at the end of the webinar if you wish.