Up until a few years ago, most home-buyers expected to have to come up with a 20% down payment when it came time to buy a house. But these days it’s far more likely to see buyers bringing just 5% to the table.
Financially speaking, most experts will tell you it’s not a good idea to borrow more than 80% of the cost of your home. This is because borrowing 80% or less allows you to skip the cost of mortgage default insurance. Providing a 20% down payment also qualifies you for lower interest rates and helps your chances at passing the OSFI mortgage stress test.
But how many people do you know who have been able to save up 20% all on their own? Doing this can take quite some time, time that may cost you the ability to keep up with the market. Say you want to save $72,000 for a property that today would cost you $360,000. If you saved $1000 a month it would take you 6 years to build up your down payment. According to this article the cost of housing increases at varying rates across the country, but lets say that in Edmonton it goes up 20% every 4 years. That means that by the time you’ve got your down payment, the property you want now costs you $474,200. Your down payment would be short by$22,840.
Making a 5% down payment is often far more achievable for home buyers, especially first-time home buyers who don’t have equity from the sale of a previous home to work with. But some buyers worry that having a small down payment will make their mortgage payments higher than they can handle. Lets compare.
The average Canadian home, according to the Canadian Real Estate Association, is $445,000. (If you take Vancouver and Toronto out of the mix the average drops to $360,000.) Lets say you’re looking at a home that costs $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
Many buyers want to avoid any extra costs, like the mandatory mortgage insurance. However, most are put at ease when they see how little it affects their monthly payments, and even more at ease when they realize that they can offset this extra cost by bargaining with their lender for a slightly lower interest rate, even 0.25%, and decrease their monthly payment.
It should be noted that current interest rates are near historic lows. When interest rates were high back in the 80s and 90s (averaging 6-15% and peaking at 18%) it was a good choice to put down a large down payment because it meant your monthly costs would be lower. But now, with the overnight rate at 1.75%, borrowing money is comparatively cheap!
If you’ve already managed to put away 20%, that’s fantastic! Well done! You have the option to use it all as a down payment, but you also have the option to invest it. You can make a 5% down payment on your house, and then invest the remaining 15% in a low-to-medium risk dividend-paying stock. When you invest in real estate you have to wait until the equity is built and your house is re-sold before you can cash in on your earnings. But with a stock investment, your earnings are more liquid and available much quicker.
To find out how to do this, or if you have more questions about down payments or the housing market in general, call us today!