One of the first things you want to consider before buying a home is how much your down payment will be and where it will come from. While there are a few rules surrounding down payments, you have plenty of options at your disposal. Understanding how down payments work will help you make the decision that’s best for you.
What Is A Down Payment?
A mortgage down payment represents the amount of cash you pay out of pocket when you purchase a home. The down payment is expressed as a percentage of the home purchase price, with the difference coming in the form of a mortgage. Typically, down payments range between 5% – 25% of a home’s purchase price, although there is really no limit to how much one can put down.
How Much Will I Need For The Down Payment On A House?
To obtain mortgage financing in Canada, you must have a minimum down payment of 5%, on a purchase price up to $500,000. In other words, if you purchased a home for $300,000, you would be required to fund at least $15,000 from your own resources. If your purchase price falls between $500,000 – $999,999, the amount over $500,000 will require 10% down. Let’s say you buy a house for $750,000. Your minimum down payment would be $50,000, calculated as follows: ($500,000 X 5% + $250,000 X 10% = $50,000). If your purchase price was $1,000,000 or higher, then you would need to put at least 20% as a down payment.
Understanding How Mortgage Loan Insurance Works
If a down payment is less than 20%, the mortgage must be protected with default insurance, often referred to as CMHC insurance. This means that the lender must obtain insurance from a third-party insurer, like Canada Mortgage and Housing Corporation (CMHC), Genworth Financial, or Canada Guaranty. These insurers cover the lender against default, should the borrower (that’s you) fail to repay the mortgage.
The cost of the insurance is passed on to the borrower in the form of a one-time premium that’s included in the mortgage financing. So, while a 5% down payment opens up homeownership to thousands of Canadians, there is a cost involved, in the form of a hefty insurance premium. Standard premiums range between .60% – 4% of the overall mortgage amount, depending on how much you put down.
Here’s an example of how the insurance premium is calculated on the purchase of a $300,000 house with a 5% down payment:
- $300,000 (purchase price) – $15,000 (down payment) = $285,000
- $285,000 X 4% insurance premium = $11,400
- $285,000 + $11,400 = $296,400
In this case, the final mortgage amount, including the insurance premium, is $296,400. Some provinces charge sales tax on the premium, but that must be paid upfront, it cannot be included in the mortgage financing.
What Is A Conventional Mortgage?
A conventional mortgage is a mortgage with at least a 20% down payment. It does not require mortgage default insurance, hence there is no insurance premium added to the mortgage. With a conventional mortgage, even though the borrower has to pay more money upfront, they’ll spend less on interest over the long run, and save thousands of dollars by avoiding the insurance premium. This doesn’t mean that a conventional mortgage is always the best option. Even if you have the funds available, you need to consider what’s best for you, given your overall financial situation.
Down Payment For First-Time Home Buyers
There are 2 government-sponsored programs available today that are designed to make it easier for first time home buyers to come up with a down payment for the purchase of a home – the First Time Home Buyers Plan (HBP), and the First Time Home Buyer Incentive. Let’s take a closer look at how each of these programs works.
The Home Buyers Plan
The Home Buyers Plan (HBP) enables qualifying Canadians to withdraw from their RRSP (Registered Retirement Savings Plan) to buy or build a home for themselves or for a family member with a disability. Up to $35,000 can be withdrawn, on the condition that the funds will be paid back in full into the RRSP within 15 years. When you withdraw the money, you will not be charged withholding tax. Funds must be in your RRSP for at least 90 days prior to withdrawal, and you must buy or build the home before October 1st of the year following your RRSP withdrawal in order to qualify.
First Time Home Buyer Incentive
The First Time Home Buyer Incentive was first announced in the federal government’s 2019 Budget. Under the program, the government will contribute 5% toward the purchase of an existing home or 5-10% toward the purchase of a newly built home. The incentive does not incur interest, although funds will need to be paid back to the government after 25 years, or when you sell the property, whichever happens first. With no monthly payments required on this long-term loan, the goal is to improve the home buyer’s affordability without a larger down payment.
Where Can My Mortgage Down Payment Come From?
There are a number of places from which a down payment can originate. The most common source is your personal savings. In other words, funds that you’ve accumulated in a savings or investment account over a period of time. As previously mentioned, first time home buyers can withdraw funds from an RRSP under the Home Buyers Plan. Also, parents can gift a down payment to their child providing that they sign a gift letter acknowledging that the funds were indeed a gift, with no expectation of repayment. We’ve compiled a full list of down payment sources below:
- Accumulated savings
- Cash out investments
- Home Buyers RRSP withdrawal (first-time home buyers)
- First Time Home Buyer Incentive
- Gift from a parent or close family member
- Funds from an inheritance
- Settlement from a marital separation
- Sale of another property
- Equity in an existing home (via a Home Equity Line of Credit)
When Is My Down Payment Due?
Now that you know what a mortgage down payment is all about, you may be wondering when you actually make the payment. When you apply for a mortgage, your lender will need to confirm that you have the funds available for the down payment, before granting final approval. Paying the down payment, however, happens closer to the possession date. In most cases, your lawyer will request that you deliver the down payment funds to their office at the time that you sign for the home purchase, which usually occurs within a week or two of possession.
Ready to get the home buying process started? Edison Financial is here to help with your home loan needs.
Tom Drake is an authority in Canadian personal finance. He is a financial analyst and has been writing about personal finance since 2009 at the award-winning MapleMoney. His work has appeared in MintLife, Canadian MoneySaver, and U.S. News & World Report, and has been quoted in The Globe and Mail, Yahoo Finance, and Financial Post.