If you’re buying your first house in today’s super-hot housing market, figuring out how much you’ll need for a down payment can be a source of concern. As home prices continue to climb in most parts of Canada, it can be discouraging to know that as you save, you still may not have enough. But exactly how much do you need? Should you try to get more money for a larger down payment, or is the minimum amount enough? Every financial situation is different, so there’s no concrete answer. However, we offer some advice and considerations in this article.
The Lower Limit on Down Payments
In Canada, all federally regulated banks and mortgage lenders require minimum down payments, which are a percentage of the purchase price of the home. If you purchase an owner-occupied home for $500,000 or less, you must make a minimum down payment of 5% to qualify for a mortgage. If the purchase price is above $500,000 and up to $999,999, the down payment required is 5% on the first $500,000 but then increases to 10% based on the value above $500,000. For example, a purchase price of $700,000 would require a $45,000 down payment ($25k and $20k). For homes purchased for $1M and above, you’ll need to put down at least 20% and typically for values above $1.5 you require 35% for the mortgage amount above $1.2M. With the average housing prices in Burlington often rocketing up over $1 million, you’ll be looking at a minimum of about 20% down payment to purchase a home. The next question is, should you plan for the minimum, or is it better to put down more?
The Difference Between High-Ratio and Low-Ratio Mortgages
When applying for a mortgage, a factor lenders consider is the size of the borrowed amount relative to the price of the home. This is called the loan-to-value ratio or LTV. If your down payment is less than 20% of the mortgage amount, the loan is considered a high-ratio mortgage. Put down more than 20%, and the LTV is considered low-ratio. That’s good to know, but how does LTV really impact your mortgage application?
Insured versus Uninsured Mortgages.
In Canada, there are several protectionary measures in place to help protect mortgage banks and lenders. One such practice requires high-ratio mortgage borrowers to pay for mandatory mortgage insurance through one of the 3 mortgage insurers, CMHC, Segan, or Canada Guarantee. Despite home buyers paying for the insurance premium (typically gets wrapped into the mortgage) the mortgage default insurance actually protects the lender from some of the risks of lending to high-ratio borrowers, and in turn, keeps interest rates lower. The premiums cost between 1.7% to 4%. With “stated income” programs (where traditional income verification is lacking) these premiums can be even larger. Premiums are calculated based on the LTV ratio of your mortgage. Simply put, the more you put down, the less percentage you’ll pay in premiums. While mandatory mortgage default insurance for “high ratio” purchases may seem like a negative, the alternative could be higher interest rates or greater difficulty in getting approved.
Then There is the Mortgage Stress Test
New mortgage applications – almost any mortgage from a federally regulated bank, that is not a renewal with the same lender – are subjected to the so-called mortgage stress test. This is a calculation used to assess whether, at the same income and debt levels, you would still qualify for your mortgage if interest rates were to rise. If you put 20% down (not a high ratio insured mortgage) then the banks have more flexibility to qualify you for the mortgage required despite the stress test. Are we any closer to determining how much is enough?
How Much Should I Plan for a Down Payment?
There is no correct answer to this question. The ‘right amount’ for your down payment depends on multiple factors. The very first one to consider is how much money you have available to you. Many first-time homebuyers use savings or investments or borrow against their RRSPs to fund a down payment. Others look to family for help with sourcing down payment funds. Before you decide to buy a new home, especially for the first time, crunch some numbers and make a budget. Get in touch with a mortgage professional to help determine how much you can afford and what amount you are likely to be pre-approved for. A mortgage broker can help in deciding on a down payment amount since it can affect the need for mortgage default insurance, the likelihood of getting final approval, and even your interest rates. A mortgage expert can help you understand all of the factors involved and to make the best choices for your financial situation.