You’ve thought about your future. You’ve done the math. You’ve thoroughly considered the pros and cons of buying or renting a property. Now that you’ve decided to buy, let’s talk down payments.
What are the rules?
A down payment is a lump sum of money paid upfront for goods or services. In the case of a property, this is a percentage of the total price of the home you’re buying (generally between 5 to 25%). The remaining amount of the home’s value is typically financed through a loan (or mortgage).
In Canada, you need a down payment of at least 5% for homes priced up to $500,000.
For homes priced over $500,000, you need a down payment of at least 5% for the first $500,000, and 10% for any remaining portion of the property’s selling price. So for example, if the property you want to purchase is listed at $800,000, you need a down payment of $55,000.
(5% of $500,000 = $25,000) +
(10% of the remaining $300,000 = $30,000)
= $55,000
Homes with a purchase value of $1,000,000 or more are not eligible for mortgage loan insurance and require a down payment of at least 20%.
Aside from the government’s rules, most lenders set a minimum percentage for your down payment before they will lend you money. That minimum depends on different factors like your credit score, credit history, and employment situation. But beyond this, there’s a few things to consider before deciding how much money to put down.
How much is in your bank account?
First, and perhaps the most obvious place to start, is the amount of money that you have saved. People who have high incomes, have been saving for a long period of time, or have inherited a large sum of money, might be able to afford a larger down payment. But younger buyers, first-time buyers, families with modest incomes, or people who only started saving recently, might not have enough money to pay more than the minimum down payment.
For many people, the difference between being able to put down a 20% down payment versus a 5% down payment is simply a matter of how much money they’ve saved.
If you’re buying a $500,000 home, a 5% down payment is equivalent to $25,000, a 15% down payment is $75,000, and a 20% down payment is equivalent to $100,000.
For an $800,000 home, you need a minimum down payment of $55,0000, but if you wanted to put 20% down, you’d need to pay $160,000 up front.
Now, let’s say you do have enough money saved up for a larger down payment. Does that mean you should spend all your savings on it?
Maybe. To tackle that question we need to break down a few things.
Liquidity
Imagine you’ve saved $75,000. That’s enough to put 15% down on a $500,000 home. But if you put every single penny of those savings towards your down payment, will you be left with nothing for a rainy day fund or emergency situation? Zero dollars for unexpected car trouble, or a vet bill. Zero dollars to attend your best friend’s wedding, which no one thought was ever actually happening, but is now suddenly very real and in the Azores, or Bali.
For many people, having some money in the bank goes a long way towards maintaining their peace of mind. If that sounds like you, you could choose a minimum down payment of 5% instead and keep a nice $50,000 cushion in your bank account.
But what is leaving that $50,000 in the bank actually costing you?
If you kept that money in a savings account for the lifetime of your mortgage, you’d hopefully be earning some interest. For the sake of argument, let’s say your bank offers a 0.350% yearly interest rate, and you decide to keep your $50,000 in there for 20 years.
Over a 20 year period, you’d earn $3,618.86 in interest, for a total value of $53,618.86.*
Hold this number in your mind for a bit (or we’ll hold it for you here!). We’ll tell you here how much it will cost you to ‘save’ that $50,000 in your bank. But for now, just keep in mind that with larger down payments, you are asking to borrow less money from your lender. So your mortgage loan insurance premiums will be lower (or non-existent, if you have that option to opt out), you will pay less interest over the life of your loan, and your payments will also be lower.
* figure was calculated using this compound interest calculator: https://www.getsmarteraboutmoney.ca/calculators/compound-interest-calculator/
Mortgage Insurance
Federal regulations in Canada state that if you put down less than 20% as a down payment for your home, you have to buy mortgage insurance.
As a general rule, people who make smaller down payments are considered riskier by lenders, so mortgage loan insurance protects lenders against default – and allows people to buy a home with a down payment of as little as 5% (for homes up to $500,000).
That means that if you don’t have enough money to cover 20% of the value of your home (or if you choose not to put down at least 20%), you will need to pay a premium for insurance. Some people will also choose to pay this premium even if they put more than 20% down.
How much the insurance premium costs is based on the loan-to-value ratio. Loan-to-value ratio is calculated by dividing the mortgage loan amount by purchase price.
To see how your premium is calculated, let’s use the example from above:
If you are buying a $500,000 home with a $25,000 down payment (or 5%), you are asking to borrow $475,000. So, you’d divide the amount of your loan, by the price of your home:
475,000 by 500,000 = 0.95
This means that you are asking the lender to cover 95% of the total value of your home. This is your loan-to-value ratio. At the time of writing, this value means that you’d be required to pay mortgage insurance premiums of approximately 4%** of your total loan.
4% mortgage insurance premium on a $475,000 loan = $19,000 for insurance
(4% of $475,000)
**The exact premium is calculated as you apply for your mortgage. Provincial sales tax sometimes apply.
If you can only afford a 5% down payment, it makes sense to pay your insurance premium as monthly or bi-weeky payments, depending on your pay schedule. But if you can put more than 5% down, you can save money in insurance premiums and interest, and lower your costs in the long run.
Take a look at the same example, but this time, with a 15% down payment.
If you are buying a $500,000 home with a $75,000 down payment (or 15%), you are asking to borrow $425,000. So, to get your loan-to-value ratio, you’d divide the amount of your loan, by the price of your home:
425,000 by 500,000 = 0.85
There are many mortgage insurance calculators that can help you figure out how much it will cost to insure your mortgage, like this one.
Essentially, the loan-to-value ratio is what you are asking the lender to cover – 85% of the total value of your home in this case.
An easier way to think of it is this: Take 100% of the price value and subtract the percentage of your down payment.
At the time of writing, with an 85% loan-to-value ratio, you’d be required to pay mortgage insurance premiums of approximately 2.80%** of your total loan.
2.80% mortgage insurance premium on a $425,000 loan = $11,900 for insurance
(2.8% of $425,000)
There’s some significant savings if we compare the two figures ($19,000 with 5% vs. $11,900 with 15%). In the long run – not accounting for interest – you’d save $7,100 dollars on mortgage insurance premiums alone by going with the larger down payment.
It’s important to note that these are simplified figures. There are other things that will come into play when talking about your mortgage, like taxes, closing costs, and interest rates. But, it’s always a good idea to consider how much money you’d owe to your lenders once insurance is factored in.
With a 5% down payment of $25,000, you would still owe $494,000 ($475,000 loan + $19,000 insurance) on your $500,000 home. On the other hand, with a 15% down payment of $75,000, you’d only owe $436,900 ($425,000 loan + $11,900 insurance) on that same home. Remember that you’ll be charged interest on this amount as you pay down your mortgage.
The catch, of course, is that in order to save both on interest and on mortgage insurance, you need to have a bigger down payment. In this example, $75,000 instead of $25,000 to pay up front.
It’s not something that everyone can afford.
If you have RRSPs, you might qualify for The Home Buyer’s Plan (HBP), which lets you withdraw funds from your Registered Retirement Savings Plan to buy a qualifying first home for yourself, or a relative with a disability. This withdrawal can be used towards putting a larger down payment. You can read more about the HBP and whether you qualify through the Government of Canada’s website.
This might sound like a lot of information. But don’t get scared off! Deciding how much of a down payment to put down is not a decision you have to make entirely alone. Talk to your financial advisor or your mortgage broker, and carefully consider your financial situation. Then, you will be one more step closer to buying the home of your dreams. Good luck!
