This is a controversial topic for many people and real estate buyers. Every real estate buyer has different goals with their purchase. But it is important to understand all your options as a buyer, and find what works best for you. And the best way to do this, is to have all the information. I will provide some interesting insights here.
The main idea I want you to consider: is it worth it to wait and save 20% down payment, or explore other options and buy sooner with 5% or 10% down. If you are waiting to save 20% down, consider the consequence of doing so.
The times have changed! It’s no longer the days of 13 to 18 percent interest rates for a mortgage. What we were taught in school no longer applies the same way it did 20 years ago. Understanding the market changes and mortgage options will help lots of buyers, specifically first time buyers, make their jump into the real estate market.
Most of my references here are in regards to the Toronto condo market, but the info here will apply to most other markets in the GTA, housing or condos.
I will break down 6 main categories and how it pertains to saving 20% down.
Without getting into too much detail, mortgage rates are favorable right now. Interests rates have been at an all time low for many years, and still float around 3% for fixed rate and even less for variable. The cost of borrowing money is really low, and with it so low, mortgage repayment is far better than it ever was. Mortgage payments are divided into 2 parts, interest and principle. With high interest rates, it used to be about 95% interest and 5% principle repayment in the early monthly payments. Meaning, years would go by and you have hardly paid any of the loan back. Lower interest rates are making the interest to principle ratio around 50/50 in the early years of repayment. Great news for buyers, as payments chip away at more of the loan.
Banks are also competing greatly for a buyer’s business. The mortgage structure is far more favorable for the buyer, with yearly loan repayment allowances. A buyer can put a large sum of money into the principle amount once per year, interest and penalty free. And now, banks are allowing upwards of 15% of the principle amount. A $400,000 mortgage, you can chip away up to 60k of the loan per year. This is all without interest or penalty.
Why save 20% down? Costs of borrowing is low, and the yearly repayment allows buyers to save money as they live in their home. Rather than wait and save for your 20% down payment in cash, buy sooner with 5% down, and utilize the yearly repayments as you save money. This will allow you to chip away at the mortgage where you can build up to having the 20% down.
This is by far the biggest reason to stop waiting for the larger down payment. As a buyer, you really must evaluate what amount of time is required to save a specific amount to get the 20% down. And, what negative implications may come from waiting for the larger down payment. Simply put, condos in Toronto are increasing in price 10% on the minimum, year over year. And in some areas even more than 10%. This market growth is not only for Toronto condos. Many GTA areas are seeing strong growth, sometimes even more aggressive than Toronto.
Saving for 20% down can easily become a chasing game of the market. You may have your eyes set on a specific property type now, but in 6 months or a year from now, it will be selling at a higher cost. A $500,000 condo today could be (and likely will be) $550,000 when you are ready. And this might be out of your price range now.
Let’s break down some numbers. You are pre qualified for a $500,000 purchase, with 5% or 20% down, your choice. You can easily buy today with $25,000 down (5%), but want to save to 20% down. 20% will be $100,000. How long will it take you to save an additional $75,000 to buy the property? 1 year, 3 years? More importantly, can you save enough to keep up with the market increase? If the market goes up 10%, then you are at a loss of $50,000.
As the market increases, not only are you at a loss of the increased value of the property, your mortgage qualifications may not have changed. The waiting period of saving to the 20% down is pushing your ideal property further and further away, becoming increasing less affordable. It is likely the banks will not approve of a higher loan to purchase the property that has increased in value. Saving to 20% might make you miss out on the property you want now, if your income levels don’t change, and your bank qualifications don’t change.
Why save 20% down? Based on yearly market increases, You may lose out on the property you want as it becomes more expensive. At the same time you may just lose out on the market appreciation, and end up paying more for the property. Buy with 5% or 10% down, get into the market, and the home you want. Build equity with the property as it increases in value, and yearly you can chip away at the principle mortgage with the penalty free repayments.
Banks Favor Insured Mortgages
Yes, you heard right! Although it seems counterintuitive for a bank lending money, to prefer a buyer with less down payment, there is a reason behind this madness. A buyer putting less than 20% down “has less skin in the game”, making the mortgage higher risk for the bank. Higher risk mortgages are required to be insured. Insured mortgages now mean less risk for the bank, even less than a buyer with 20% down payment. The mortgage insurance companies have a very strict approval process for the buyer, even more so than the banks.
Banks prefer insured mortgages so much, they will offer better interest rates for mortgages with less than 20% down. Interest rates are the biggest contributor to monthly payment costs, often times, more so than the down payment amount. A lower interest rate can significantly reduce a buyer’s monthly costs.
Why Save 20% Down? This is a huge consideration for buyers. Even if a buyer has 20% down payment, it might make sense not to put the full 20%. Consider doing 15%, take advantage of the lower interest rate, reduce your monthly payments, and keep some cash in the bank.
CMHC insurance costs
If you have agreed with me on the 3 points I have addressed so far, this might be where you have gotten discouraged.
What is CMHC Insurance? It is a fixed percent of the loan amount, that is charged to the buyer for the privilege of putting less than 20% down. Banks will only lend money, with less than 20% down from the buyer if the mortgage is insured. The insurance fee is based on a percent that changes based on the down payment percent. The less down, the slightly higher the percent.
The good news is, the fee is built into to the monthly payments. A buyer does not need to pay the amount upfront as a closing cost. Yes, the fee still exists and you are paying for it. But being built into the monthly payments, it’s a lot easier to budget for. And it doesn’t cut into your closing costs when buying the property. As mentioned above, the lower interest rates often make up for the fee being built into the mortgage, making your payments even lower.
Here is something to consider. If you are looking for a $500,000 condo (or any property type), you usually have wiggle room of $10,000 to $20,000 on your purchase price. You are willing to pay in the range of $490,000 to $520,000, if it means getting the property you want. And these very minor differences in purchase price for you as the buyer, mean the difference of a few dollars more, or less per month on your monthly mortgage payments. If you are willing to do that, the CMHC insurance fee is the same thing. It’s built into the payments, and hardly makes any difference to your purchase.
Why save 20% down? The monthly costs of the insurance premium is generally wiped out by the lower interest rates, and lower monthly payments. It’s a small premium, built into your payments, for the luxury of not needing an extra $50,000+ cash down payment.
Renting while saving
Let’s jump right into this one. If you are currently renting a condo (and this applies to most property types and areas), you can afford the monthly cost of living. It is usually about the same, if not less cost to own than to rent. Likely while you are paying rent, it will be increasing difficult to save for a down payment. This intensifies the point above about the market, if it is taking longer to save to 20%, than the market will continue to grow, pushing you further and further from getting into the market.
Also, renting puts you at a disadvantage of not reaping the rewards of the market increases. Monthly rental costs are going into the costs of living in the property, but you are not getting any of the advantages.
Why save 20% down? You can afford the cost of renting, you just need a down payment. Use the minimum amount needed, 5% or 10% to just get in. Now your monthly expenses are going into your investment that will have great future value.
5% vs. 10% vs. 15% vs. 20%
Interesting thing to consider, as to what down payment makes most sense for you. Every buyer will have different financial goals and abilities with their purchase. It’s important to look at the monthly cost difference for alternative down payment amounts. Generally, there is not a big monthly cost difference between 5 or 10 percent, or 10 and 15 percent. Maybe around $100 per month. But the cash difference needed for the down payment is within $25,000 to $50,000, or more. This is where the big difference is really noticeable. Check your monthly payments here: https://www.bmo.com/main/personal/mortgages/calculators/payment-calculator/
CMHC insurance premiums will increase with the lower down payments. But again, being built into the mortgage, a few thousand dollars may not make a difference. If you’re putting 5% down on the property, you must budget for the increase down payment for the portion above $500,000. Example: A $570,000 purchase will require a $32,000 down payment. Only the amount above 500,000 will be subject to 10% down minimums. It’s not, once you pay over 500,000, you need 10% down of the whole purchase price.
Why save 20% down? When you look into the monthly payments, which is the most important consideration when buying a property, you will see very minor differences in the monthly payments between the down payment options. It is important to consider if the minor monthly payment difference is worth the large down payment difference. Example: on a $500,000 purchase, 10% down vs. 15% down might be the monthly difference of $100 or so, but the cash down payment difference is $25,000 upfront.
– The waiting game to save 20% down might make you miss out on the market, or property type you want, pushing the market further and further away.
– Renting may amplify the point above, as the cost of renting may be hindering your ability to save for the down payment.
– Banks will offer better rates for insured mortgages, reducing your monthly payment costs.
– Lower costs of borrowing, combined with yearly repayments without penalties, makes borrowing easier.
– The difference between 15% and 20% down may have a positive effect on reduced monthly costs, and allow you to keep more money in the bank.
– Mortgage insurance costs are built into the monthly payments, not an upfront cost.
If saving to 20% is what you are waiting for, to buy real estate, take a moment to explore other options available to you. It might save you lots of money in the long run, and in the short term.