When you envision yourself making a down payment on your very first home, how much do you see yourself putting down? Is it 20% like many of the generation before you? Or is it 5% like more and more first-time home buyers today?
The common consensus among financial experts has been that home buyers shouldn’t borrow more than 80% of the purchase price of their home. This is because borrowing more than that can increase your interest rate, decrease your ability to pass the OSFI mortgage stress test, and automatically forces you to pay mortgage default insurance.
However, more and more first-time home buyers are finding it difficult to come up with a 20% down payment on their own. Many first-time buyers rely on a gifted down payment from a family member, borrowing from their RRSPs (if they’ve saved enough), or selling their first born. (Not really. Don’t call CFS.) Saving a 20% down payment on your own may be manageable if you have a dual income household, no debt and no children. But for those with families, single incomes, and/or other financial obligations, saving just isn’t realistic. Not only can it take longer than you want, but it can take longer than you can afford.
Lets say you have a budget of $360,000 for your first house and you can afford to save $1000 a month. It’ll take you 6 years to save $72,000 (20%.) But by the time you’ve saved it, the 2 bedroom starter home you had planned on now costs $474,200. Your savings isn’t 20% anymore. You still need another $22,840. Aiming to save just 5% is often far more achievable for many first-time home buyers.
According to the Canadian Real Estate Association, the average Canadian home is $445,000. (Outside of Vancouver and Toronto the average is $360,000). Lets compare a 5% down payment to a 20% down payment on a mortgage of $455,000 amortized at 3.24% with a 5-year fixed rate over 25 years.
- 5% down = $22,750; monthly mortgage payment = $2,180; mandatory mortgage insurance = $17,300
- 20% down = $91,000; monthly mortgage payment = $1,770; mandatory mortgage insurance = $0
When you’re making a big purchase like a home, the idea of adding any extra expenses can be aggravating. However, the additional expense of mortgage default insurance can be offset by bargaining for a slightly lower interest rate. Even 0.25% less can be enough to chip away at your monthly payment and make it more affordable.
Keep in mind, interest rates are near historic lows which means that the cost of borrowing money is relatively cheap, especially compared to the sky-high interest rates of the 80s and 90s which averaged 6-15% and peaked at 18% in 1982. In those circumstances it made sense to make a large down payment because it helped to keep your monthly mortgage payment low. But in today’s economic climate, a smaller down payment is feasible.
If you’re reading this and have already your 20% down payment stowed away, congratulations! That kind of achievement is not easy! You have the option to use it all as a down payment, or you can put just 5% down and put the remainder in an investment. A low-to-medium risk dividend-paying stock will make your cash more fluid and give you access to your earnings much more quickly than waiting for the equity in your home to build.
To find out more about down payments or mortgages contact us today.