Taking current economic and fiscal realities into account, it would be far more sensible to pay the initial 20 per cent down payment for a home purchase in full instead of saving the money for later, according to a veteran industry analyst.
In a March 10 piece for The Globe and Mail, markets observer Rob Carrick argued that the mortgage environment of today does not favor those who carefully save and spend their hard-earned funds.
“Home buyers who put less than 20 per cent down are seen as risky enough to require that they pay the cost of default insurance for their lender. But the best mortgage rates are in some cases going to people with small down payments,” Carrick wrote.
“The indignities for diligent savers are piling up. You’ll earn next to no interest on your savings, and then some mortgage lenders withhold their best rates when you buy a house.”
Carrick added that the increased popularity of high-ratio mortgages has led to the taxpaying public essentially bankrolling these mortgages in the event of defaults.
“Because they’re basically risk-free, high-ratio mortgages get the lowest rates at alternative lenders. The big banks, with their greater financial strength, don’t much look at down-payment size in setting mortgage rate discounts for in-branch clients,” Carrick explained. “But there are signs of a new favouritism toward people putting less than 20 per cent down. In a recent Bank of Montreal promotion offering up to $1,000 cash to first-time buyers, one of the conditions is that they require mortgage-default insurance.”
“Discrimination against people who save big down payments might be addressed if regulators follow through on a proposal to have lenders share some of the risk if an insured mortgage goes into default.”
In addition, RateSpy’s Robert McLister highlighted an additional benefit to fully paying the 20 per cent:
More equity will prove invaluable to maintaining solvency, especially if residential sale prices decline.
Should I Wait For A 20% Down Payment?
We hear a lot of home-buyers saving aggressively nowadays in order to facilitate a large down payment on a home.
Many of them aim for the coveted 20% down payment as a means of avoiding high-ratio mortgage insurance (we’ll refer to it solely as CMHC for the purpose of this article).
Their reasoning is that there’s no need to pay a premium for borrowing money, and CMHC is just another premium. Well, that’s not exactly the case.
If someone has 19% saved and can easily push themselves to 20% then it makes perfect sense to do so. But what about people that currently only have 5%? 10%? 15%? CMHC becomes a much more feasible route at that point.
Originally, it was found that people could easily afford to carry a mortgage – the problem was that it was often difficult for families to come up with a down payment large enough to make the banks comfortable.
That’s where CMHC came into play.
They bridged the gap by allowing people to borrow up to 95% of their purchase while giving banks the security they needed in order to lend that high.
So instead of looking at CMHC as penalizing someone for not having enough of a down payment, it is more accurate to say they help people with smaller down payments that would have otherwise not been eligible for homeownership yet.
But as is always the case with mortgages, let’s talk real numbers.
Let’s imagine a client – we’ll call him Frankie Firsttimer – looking to purchase for around $700,000. Now imagine Frankie earns an annual salary of $115,000 and has enough savings to cover 10% ($70,000) plus closings costs.
Frankie wants nothing to do with CMHC as there is a stigma behind paying a premium on a mortgage so he wants to put 20% down when he purchases. Let’s assume he can comfortably put away $1,500 per month into a savings account to bulk up his down payment.
At this rate, it will take Frankie nearly 4 years to save the remaining 10% of his down payment. In this time he may come into money through an inheritance, a raise, a return on an investment, the lottery, or some benevolent billionaire, which would all shorten his timeline. But let’s set that aside because there will also be rent payments, unexpected vehicle expenses, vacations, etc.
Now let’s imagine another client – we’ll call her Betty Buynow – who is in the exact same position as Frankie Firsttimer but is eager to get into a home today. Because she only has 10% down, her CMHC premium would be 2.4% of her mortgage (this is rolled into the mortgage and amortized over the life of the loan). I’ve laid it out here:
Purchase – $700,000
Down Payment – $70,000
Mortgage – $630,000
CMHC Premium (2.4%) – $15,120
Total Loan – $645,120
If Betty buys today, her mortgage payment will be $2,951 per month*. How does that compare to Frankie’s payment if he puts 20% down and avoids the premium? Let’s examine his scenario below:
Purchase – $700,000
Down Payment – $140,000
Mortgage – $560,000
CMHC Premium – $0
Total Loan – $560,000
Frankie’s monthly payment in this scenario could be as low as $2,263** depending on how he chooses to amortize. CMHC allows for a maximum amortization of 25 years whereas a non-insured mortgage can be amortized up to 30 years.
By just looking at monthly payments, Frankie is way ahead of the game because he’s borrowed less and didn’t have to pay a premium on his mortgage – a savings of almost $700 per month. But what about the last four years that Betty has owned a home and Frankie hasn’t?
For example the BC housing market can appreciate by 5-10% per year depending on season, month, region, and property type. Let’s go with the more modest end of things and assume Betty’s home has only gone up by 5% per year.
In the four years it’s taken Frankie to save his down payment, Betty’s home as appreciated to a market value of $893,395. She’s also paid down her mortgage by $76,570 meaning her net worth has increased by roughly $270,000 (not including her original down payment).
And as for Frankie? Well, the $700,000 home he was looking at 4 years ago has now appreciated out of his price range. So his $700,000 is going to get him less house/condo than it would have earlier. But again, let’s examine the numbers at the 4-year mark.
Betty’s situation after 4 years:
Property – $893,395
Mortgage balance – $568,547
Net worth – $324,848
Frankie’s situation after 4 years:
Property – $700,000
Mortgage balance – $560,000
Net worth – $140,000
If Frankie has lived with his parents all these years, the above numbers apply and that’s the end of it. But while Betty has been spending $2,951 per month in a mortgage, Frankie may very well have been spending $2,000 per month in rent without building any equity at all.
This would mean he has paid $96,000 to his landlord in that time. While this won’t affect his net worth in the end, it is money that could have been better spent. This is, again, situational but rent should absolutely be accounted for when making decisions.
Each mortgage payment you make contributes to principal and each year you stay in your home contributes to appreciation. The above are very general examples but they perfectly illustrate the effect time can have on your biggest investment you’re possibly ever going to make. Bear in mind; over the last two decades, appreciation has reached record highs – much higher than the 5% used above – but there is no guaranteeing what the future holds.
So, should Frankie have waited?
Well, the truth is people save at different rates and they realize appreciation differently from property to property. Income, rent, expenses, preferences, and careers can all change. But in the grand scheme of things, was waiting worth saving a few hundred dollars a month? No. Should Frankie have purchased when he had only 10%? Possibly.
But the better questions is, should he have allowed the stigma of CMHC to affect his buying decision?
He should have spoken with a professional who could have run these numbers for him and determined what sort of timeline would have worked best for his situation. Why worry about a mortgage that is under 3% per year when your home appreciates at more than 5%?
Conversely, why take the plunge when you can live more comfortably by holding off a year or two. This article is not intended to sway you either way, but instead to make you think.
Take the time to examine these numbers. Be mindful of all factors that are going to influence your life over the next several years.
Speak to a professional. But please, don’t allow stigma to be the one thing keeping you from an incredible opportunity.
* Mortgage payments calculated at 2.69% compounded semi-annually and amortized over 25 years.
** Mortgage payment calculated at 2.69% compounded semi-annually and amortized over 30 years.