When you are deciding to buy your first home, one of the questions that often comes up is: how much should I pay for my down payment?
The short answer is: as much as possible.
Image: Rick / Flickr
We’ve all seen the havoc that some of the no-down payment mortgages in the U.S. have caused. Since buyers of these mortgages have put almost no equity into their homes, their amortization periods are generally long, and their interest rates high. Even worse, when their home price dropped (as it did in some bubbly markets), their mortgage can potentially become greater than the price of their home. This makes it impossible to sell without incurring a debt, even if they can no longer afford their mortgage payments. This is not a situation you want to get into.
In Canada, it is federally mandated that home buyers must pay at least 5% of their property’s cost in a down payment. Finance Minister Flaherty has even suggested that the government may raise this in the future, although he was not clear on what it would be raised to. Most experts agree that if he does raise it, it will probably be raised to around 7.5%-10%.
Nevertheless, a much better benchmark to aim for is around 20%. In fact, the Canadian Bank Act prevents any registered lender from lending more than 80% of the cost of a property to a customer without requiring them to also get mortgage insurance. Mortgage insurance basically covers the lender in the eventuality that you can’t pay your mortgage payments. Mortgage insurance varies depending on your down payment, but it is generally around 0.5% to 1% of your total home value per year. This may not sound like much, but it is essentially money that isn’t going toward your mortgage.
There are other options if you want to avoid mortgage insurance. You can also take out two loans so that neither loan is worth 80% of your home’s value. However, the second loan will likely have an interest rate that is substantially higher than standard mortgage rates – it could even hit 9% or 10%.
As I said, generally, the more you can pay up front, the better. In the long run, it will help you save a lot of money in interest payments, and it will shorten up your amortization period.
Also: think of it as insurance. In the first few years of your home ownership, your mortgage payments are not making much of a dent in your debt, and are largely just interest payments. If there is a correction in the market and you are forced to sell, your down payment will be there to help cushion the blow.
And finally: it should also be a barometer as to whether you can afford a home or not. You may feel that you need to buy a home simply because everyone else is. But not being able to afford 20% on your down payment could mean you are not ready to buy, or not ready to buy the home you really want.
In situations like these, it’s always good to be a little patient. When you are ready, the home of your dreams will be ready for you.
Nelson Goulart
Broker of Record with Signature Service GMAC Real Estate
www.ssgmac.ca
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