How much do you need for a down payment? 20%? 10%? 5%? In previous generations the goal was for 20% but in today’s economic climate, just 5% is accepted by nearly everyone.
Many financial experts will tell you it is not a good idea to borrow more than 80% of the cost of your home, but it isn’t mandatory. The reason some buyers prefer to put down 20% or more is because it means they won’t have to pay mortgage default insurance, and because it will help their likelihood of passing the OSFI mortgage stress test and give them access to lower interest rates.
Mortgage default insurance may seem like a lot of money overall but when it is broken up over the lifetime of your mortgage it is a manageable cost. Plus, you can bargain with your lender for a slightly lower interest rate in order to offset the cost of this additional insurance. Even a reduction of 0.25% can be enough to lower your monthly payments to something more agreeable. Speaking of interest rates, currently they are near historic lows! Back in the 80s and 90s interest rates hovered around 6%-15% and peaked at 18% in 1982. Relatively, today rates are much much lower.
When interest rates were high it made the most amount of sense for buyers to make a large down payment in order to minimize their monthly payments. But today interest rates are low and making a smaller down payment is agreeable. 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 take a look at the difference between a 5% and a 20% down payment.
Example: $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
Saving up a 20% down payment is often a huge obstacle for people shopping for a home, especially first-time home buyers who don’t have equity from a previous home sale to work with. Depending on how much cash you’re setting aside every month to save up your down payment, you may not be able to save money fast enough to keep up with the growth of housing prices. For example, say you set aside $1000 every month for a house with a maximum purchase price of $360,000. In 6 years you’ have $72,000, or 20% (assuming you haven’t put this money in an interest accumulating account.) According to this article the cost of housing increases at varying rates across the country, but lets say the cost of housing in Red Deer goes up 20% every 4 years. That means by the time you’ve saved your down payment, the house you’d been aiming for now costs $474,200 and your 20% down payment would be $94,840, nearly $23,000 more than what you have.
If you already have managed to put together a 20% down payment you should give yourself a very hard earned pat on the back! Many people find it very difficult to get themselves into your position, possibly even yourself! You can put your entire savings into your down payment, but doing this ties up your investment into the equity of your home. You won’t see a return until the value of your house has appreciated and you’ve sold it and cashed in on your earnings. If you’d prefer to see quicker returns with more fluidity you could consider making a 5% down payment and then investing the rest of your savings into a low-to-moderate risk dividend-paying stock.
To find out what options are available to you today, please contact us.