I hear this question a lot! It's probably because down payment rules have changed quite a bit over the last few years. All these changes create uncertainty, confusion and plenty of myths. My clients typically ask, "How much money do I need to purchase a home?"
The minimum down payment to purchase your principle residence or a vacation home in Canada is 5% of the total purchase price up to $500,000. Whether you are a first time home buyer or if this is your next home purchase, five percent is the minimum down payment. A home purchase with less than 20% down will require mortgage default insurance.
Over the years, the government has made changes to mortgage rules to help with affordability or to slow down certain markets or for other reasons. As I review all the changes, I think they butt their noses in too much.
One of the more recent changes occurred on December 2015. The Government of Canada Finance Department announced a change to minimum down payment requirements. For a purchase price over $500,000, purchasers are required to have 10% for the portion of the purchase price above $500,000.
For example: A purchase price of $750,000, a purchaser would have a down payment of $50,000. This would be calculated as 5% of the first $500,000 ($25,000) plus 10% of the remaining $250k ($25,000).
Another example: A purchase of $900,000 would require a down payment of $65,000. Calculated by adding $25,000 that represents 5% of the first $500,000 of the purchase price plus $40,000 that represents 10% of the remaining $400,000 of the purchase price.
In October 2016, the Government of Canada Finance Department made a further change to down payment requirements for home purchases of $1,000,000 and greater.
A home purchase of $1 million or more is no longer eligible for mortgage default insurance and therefore the minimum down payment is 20% for home purchases over $1,000,000.
Myth: I thought that only First Time Home Buyers could purchase with 5% down?
There was a time when only first time home buyers could purchase with 5% down. Today, anyone can purchase a home with five percent down. Provided you are purchasing your principle residence or a vacation home (also known as a second residence), you can buy with as little as 5% down.
Can I purchase with zero down?
From November 2006 to July 2008 you were able to purchase with zero down. Today, the minimum down payment is 5% of the purchase price.
There are however programs available today through some lenders (not all lenders!) that will allow you to borrow the down payment. This program is called flex down.
For a flex down payment mortgage, you can set up a loan for the 5% down payment required and use the proceeds of this loan to purchase your home. The payments for this loan are included in the qualifying calculations for to purchase your home.
How does the Flex Down Payment Program Work?
To qualify for a flex down payment mortgage, you must have good credit, a credit score above 680. You also need the ability to make this loan payment and your mortgage payments. The default insurer will charge a slightly higher premium for a flex down mortgage.
When you choose this as an option for your home purchase you will be making a principle and interest payment for your mortgage. You will pay property taxes for your home. You could be paying condo fees. You will also pay principle and interest payments on a loan that would be amortized over 5 years, or less.
The flex down payment program could add upwards of $500 or $600 per month to your housing costs.
In general, clients who have excellent credit and little debt can make this work. If you have car payments and credit balances and other debt, then this flex down program isn't the best solution for you, in my opinion.
Every client situation is different. If you are thinking about this as a potential program for your next home purchase, consider your budget.
A mortgage broker can help clarify if this works for you. Your mortgage broker can illustrate your total monthly housing costs, as well as estimated loan payment costs. This way you will understand your cash flow and whether this would work for you and your family or not.
I highly recommend speaking with a mortgage broker who would have access to lenders offering this. Not every bank can offer this to clients. Many won't even mention this program to you.
How does the default insurance work with my down payment?
When you have less than 20% down, then you will require mortgage default insurance. There are 3 default mortgage insurers in Canada. CMHC is government owned, Genworth and Canada Guarantee are private corporations.
Each underwrite and review applications differently, but they all charge the same premiums. You can find their respective premiums by following these links:
You will notice that for a down payment of 5% up to but less than 10%, the default premium is 4% of the mortgage amount requested. For 10% down up to but less than 15% the premium is 3.10%. For 15% down up to but less than 20% down, the premium is 2.80%. The insurers will provide premiums for 20%, 25%, 30% down etc, but it's not necessarily required if you have 20% or more down.
When you evaluate how much down payment you should provide, the greatest savings is when you can save 10% vs. 5% down payment. Coming up with 20% will certainly provide you the best overall savings in premium.
With under 20% down, your maximum mortgage amortization is 25 years. Let's compare the premium and payments for a home purchase of $400,000 with a down payment of 5% versus 10% (using an interest rate of 2.99%):
- $400,000 Purchase price
- $20,000 5% Down payment
- $15,200 Premium calculated as 4% of $380,000
- $395,200 Mortgage balance
- $1,868 Monthly principle & interest mortgage payment
- $400,000 Purchase price
- $40,000 10% Down payment
- $11,160 Premium calculated as 3.1% of $360,000
- $371,160 Mortgage balance
- $1,755 Monthly principle & interest mortgage payment
As you can see from these numbers, you save approximately $4,000 in premium when you increase your down payment by $20,000 (5%). You will also reduce your payments by approximately $113 per month.
For a first time home buyer, if you have saved 10% down, it might be more prudent to keep the money in your bank account and choose the slightly higher payment. This way, you have access to cash if you need it down the road.
There is a government incentive program beginning September 2019 which will provide first time home buyers, who meet specific qualifications with an interest free loan for 5% or 10% of the purchase price. The amount of incentive is determined by whether you are buying a new or existing home.
I wrote about this program here. I think it's a good program, if you qualify.
Let's talk about sources of your down payment
Depending on your situation there are a number of ways for you to secure the down payment. I thought I would review these options a little and potentially show you some that you may not have known:
- Save the down payment
- Borrow the down payment
- Gift for the down payment from relatives
- Utilize RRSP savings for the down payment
- RRSP down payment strategy
- Sell a property you currently own for the down payment
- Refinance a property you own for the down payment
Save The Down Payment
For many first time home buyers, this is their only option. If you are struggling with your savings plan, I suggest tracking your spending for 1 month. After that month, use cash to purchase your day to day items instead of credit or debit.
Allow yourself to spend only 20% of your net income each pay period for active expenses. These active expenses are purchases that you make a decision when you buy. Purchases like eating out, groceries, movies, gifts, etc. It's the active spending that become habits that burn away your extra cash flow.
One of my clients tracked her spending for a month. She realized that she was spending over $450 on Tim's. She would buy a coffee and danish or a coffee with something else. Every time her spend was under $5 but she went there often.
One she started tracking her spending and making choices with her money, instead of just flashing her card. Her savings began to build up fast. She still went to Tim's occasionally, but not 2-3x per day.
Borrow The Down Payment
I reviewed this earlier but can't miss it in this list. You can borrow the down payment with a loan. You will be responsible for the loan payment, the mortgage payment, property taxes, condo fees (if applicable), heat, water and electricity.
To borrow, you must have a credit score above 680, you should have little other debt, and have the ability to make the mortgage an loan payments.
Gift From Relatives for the Down Payment
When I work with first time home buyers, this is the most common source of the down payment. Parents or grand parents are usually pitching in some funds, if not all the funds, to help cover the down payment costs.
For a gifted down payment, the gift must come from an immediate family member. Mother, father, brother, sister, grand parent, uncle or aunt can all provide the gift. Lenders are weary about gifts from employers or friends. Some lender's don't allow it and others ask for more due diligence, meaning more paperwork.
Utilize RRSP's for First Time Home Buyers
As of the 2019 Federal Budget, first time home buyers plan allows you to draw up to $35k from their RSP tax free to use toward a home purchase. This is one of the few times you can draw funds from your RSP tax free.
There are a couple of key rules that you should know about using your RSP under the first time home buyer plan:
- to draw the funds from your RSP, the money must be in the RSP for a minimum of 90 days
- you can withdraw the money from your RSP more then 1x up to the possession date in the same calendar year
- you can withdraw up to 30 days after your possession date
- you have to pay back the funds you withdrew under the home buyers plan over 15 years
- if you do not pay back 1/15th of the funds any given year, then you would declare that amount as income on your income tax return and pay taxes for that portion. This will not kick you out of the program by missing one year.
One thing that I've noticed with clients today is that they tend to save their down payment in a TFSA (Tax Free Savings Account) instead of an RSP. Because of this, I have helped clients to increase their available funds by up to 35%. To do this, the have to shuffle their money around a little.
Let's look at an example: Sarah, a first time home buyer, has $30,000 saved in a Tax Free Savings Account. She was planning to purchase a home in 6 months from now. She was also planning to use the $30,000 she had saved for her down payment. Sarah earns $95,000 and her marginal tax rate is 30%.
If Sarah transfers the $30,000 to an RSP now, she will receive a tax receipt for the contribution. The tax receipt will reduce her taxable income for this year by $30,000. She would potentially receive $9,000 back after she files her income tax return in April of next year.
Sarah must keep the money in her RSP for 90 days. After 90 days, as a first time home buyer, she can withdraw the $30,000 and use that toward the purchase of her home. She will have an obligation to pay back her RSP by $2,000 for the next 15 years (approx $167/month)
By shuffling the money from her TFSA to her RSP, she has generated a potential return of $9,000. She can use this money for anything she wants. She could pay down her mortgage. She could deposit money back into her RSP. She transfer it back to her TFSA. She would get to choose.
I have suggested this to many clients who almost always take advantage of this strategy. To accomplish this, it's best to plan early. Because of the home buyer rule that states the money must remain in the RSP for a minimum of 90 days, you must shuffle things around early enough.
This can also be done with a gift. If Sarah's parents were going to give her a gift of $30,000 and she didn't have the down payment saved, she could have deposited the gift into an RSP, then drawn the funds out after 90 days for her home purchase. She would effectively receive $39,000 from her parents. A nice way to grow her money without any risk.
RRSP Strategy for Down Payment
I the last section, I explained how first time home buyers can take advantage of a government program called the home buyers plan.
For purchasers who don't have the money saved up and who don't have a gift from a relative. We can combine the borrowed down payment strategy with the RSP strategy.
Basically, you can set up an RSP loan with an extend amortization of 5 years or 7 years. Some banks will offer RSP loans with amortizations up to 10 years. For $30,000, the payment would be approximately $575/month.
If you set up this loan before the end of February in any given year, then you can use this RSP contribution on your income for the previous year. You should receive approximately 30% back from your tax return, depending on your marginal tax rate and whether or not your income tax contributions were close to what you owe.
This tax refund and RSP can be used toward your home purchase. You would then be responsible for paying back the loan as well as paying back your RSP each year along with your new housing costs.
Let's look at an example: Meaghan and Cory want to purchase a home for $400,000 but have no savings or gifts available. They don't have any debt. The each earn approx $65,000 and set up an RSP for $20,000 each by taking a $20,000 loan with payments of $385/month from the bank.
After filing their income tax returns, they each receive $6,000 back from the government for a total of $12,000. The find a home and write an offer on the home. The minimum down payment is $20,000.
- Meaghan has $6,000 in a savings account, she has an RSP worth $20,000 and an RSP loan for $20,000 with payments of $385 per month.
- Cory has $6,000 in a savings account, he has an RSP worth $20,000 and an RSP loan for $20,000 with a monthly payment of $385.
They each draw out $20,000 from their RSP. Meaghan uses the money to pay off her RSP loan. This leaves Meaghan with $6,000 for the down payment
Cory uses $10,000 to pay down his RSP loan from $20,000 to $10,000 and the bank reduces the payment on that loan from $385/month to $235/month. Cory has $6,000 in his savings and $10,000 left after paying down the loan.
Together, they have $22,000 in cash. $20,000 can go toward the purchase of their home. $2,000 can be used for closing costs to finalize their purchase with a lawyer.
Once they move into their home, they are responsible for the mortgage payments, property taxes, heating costs, condo fees (if applicable), electricity, water, etc., they also have a $10,000 loan with payments of $235/month. By using RSP's under the home buyer plan, they will have to pay back $1334/year or $111/month each.
By utilizing this strategy, they are able to buy a home, but they do have a total monthly obligation of $457/month. $235/month for the loan and $111/month each for the RSP repayment.
Note, the RSP repayment is not mandatory. If they fail to make this payment, then their income for that year would show $1334 more and they would pay their marginal tax rate of tax on that income.
Notice, they didn't have to use all the RSP month for the down payment. They could allocate the funds as they see fit. The funds and this strategy was available for them because they were first time home buyers.
Sell a Property For The Down Payment
If you can sell a property, they you aren't considered a first time home buyer. Most clients who own a home and want to move to a new home will sell their existing home and use the next proceeds from the sale for the purchase.
The net proceeds would the the funds remaining. To calculate this, take your sale price, minus the mortgage balance, penalty (if applicable), real estate fees, closing costs, legal fees, etc..
If you own a home and the sale date happens after the purchase date, then the lender would arrange interim financing for you. Basically, they lend you the money for the down payment, then require your lawyer to pay off the loan when your home is sold.
Interim financing is only available if your home has a firm sale, that is, there are no conditions on the sale of your home.
For interim financing, lenders typically charge a fee ($250 to $500) and they will charge interest (prime plus 2% to 4%). If your home isn't sold and you are taking possession of your next home, then you can't qualify for interim financing but you could refinance your home to get the down payment.
Refinance a Property For The Down Payment
Some clients either can't sell their home in time or don't want to keep their home as an investment (rental) property. In this case, you can refinance your current home to get access to some of the equity for the down payment on your next home.
When you refinance your home, you can only finance up to 80% of the value, therefore you need to have enough built up equity to get cash out.
I wrote about the options for doing this on this article called: "How Much Mortgage Can I Borrow Against My Home?"
Image source (my daughter and son-in-law)