Down Payment Basics
Once you’ve decided to buy a home, the next order of business is to figure out how much you can afford to spend. This includes deciding on the amount you want to pay up front in the form of a down payment. In general, down payments are five, ten or twenty percent of the cost of the home, although there are some financing plans that don’t require a down payment. Each one has its benefits and drawbacks, and we’ll explain some of them.
The Amount Borrowed Makes a Difference
Mortgages for homes that are $500,000 or less will almost always require a minimum five percent down payment. If the purchase exceeds this figure, the remaining balance will require a ten percent down payment. For example, a $700,000 home will require a down payment of $45,000. Here’s how it’s calculated:
$500,000 x 5 percent = $25,000
$200,000 x 10 percent = $20,000
Total:Â $45,000
Mortgage Loan Insurance
Another wrinkle in the mortgage process is something called mortgage loan insurance. This is an insurance premium added to loans that have less than a 20 percent down payment, and it’s in place to protect the lender in case of default on the loan. This can add up to $10,000 or more to your loan, depending on the amount you’re borrowing.
First, the home loan must meet the requirements of the mortgage insurance company. Then the insurer will add a premium of .6 percent to 4.5 percent to the total sum you borrow. The good news is that the mortgage insurance fee can be rolled into the amount you’re borrowing. Remember, though, that you’ll be paying interest on that amount as well.Â
Size of Down Payment
The larger down payment you can make, the better off you’ll be in the size of your monthly house payments. If you come up with 20 percent down, this will avoid the added expense of a mortgage insurance premium. In Quebec, Ontario and Manitoba you’ll also have to pay provincial taxes on mortgage insurance, and this amount can’t be added to the loan.Â
Sources of Down Payment
The best way to come up with the money for a down payment on your home is to save for it. The more you can put down up front, the lower your monthly mortgage payments will be. Gifts from immediate family members may also be used to meet the down payment. Borrowing the money or withdrawing money from your retirement savings should be a last resort.
The Home Buyers’ Plan (HBP) allows first-time buyers to take up to $25,000 from their Registered Retirement Savings Plan (RRSP) to use toward a down payment on a new home. There are three reasons to avoid this option if you don’t need it:
1. Although you have up to fifteen years to repay the loan, this is another payment on top of your monthly home mortgage payment.
2. If you are unable to pay back the money, it will be taxed, leaving you owing more in income tax.
3. It will have a negative effect on your retirement savings. Even if you do replenish your retirement fund, that money will not have been earning interest in the meantime.
Tip: If you add money to your RRSP as repayment of an HBP down payment loan, be sure and designate it as such. If you don’t, it will be counted as a regular contribution.
Consider all the Factors
These are the basics when it comes to figuring out how much you’ll need to raise for a down payment on your new home. The difference between financing a home under or over $500,000 will affect your down payment. Closing costs will add another 1.5 to 4 percent to the cost of the loan. Once you’re prepared with these facts about taking out a home loan, you’ll be ready to decide what your down payment will be.
Be sure to read about the changes to the mortgage rules in Canada that will take effect on January 1st, 2018 and is expected to affect all home buyers.
