Is a 20 per cent down payment on your new home really going to get you the best interest rate?

As a homeowner, it’s likely that your home will be your largest asset. Your home may be worth more than all of your other investments combined, even.

But buying a home is not a simple task. There are many challenges that come into play when you’re in the market to buy a home.

With speaking to many of my clients who are first time homebuyers, the number one obstacle to homeownership is saving for a down payment.

What exactly is the down payment? It’s the amount of money that you, the buyer, kick in out of your own pocket toward the purchase of the house.

Down payments vary in size and are typically described in percentage terms as compared to the sale price. For example, if you’re buying a home for $400,000, and your down payment is $80,000, you are then putting 20 per cent down, or the loan to value is 80 per cent.

But exactly how much do you need to put down?

While 5% per cent is the minimum down payment for a property that will be your principal residence or a second home, some lenders say that 20 per cent is a good rule of thumb.

When you’re buying a new home, however, about the riskiest thing you can do is to make the largest down payment you can. It’s conservative to borrow more.

The first and biggest reason to come up with 20 percent down is to avoid the Mortgage Default Insurance (ie. CMHC, Canada Guaranty and Genworth are the three default insurers in Canada). And with the premium increase on March 17, the cost of putting less than 20 per cent down just went up. Click here to see the new premiums.

The loan programs that once existed for zero percent down payments are now a thing of the past. Some lenders are even getting a lot pickier about who they approve for 5 per cent down – they may want the down payment, or at least a portion, to come from your own resources (not a gift or borrowed), They may also consider your overall net-worth.

It is true that a significant down payment builds instant equity in your home. A 20 percent down payment immediately puts equity into a property when you purchase it. That down payment safeguards you if the market turns downward temporarily.

There is an opportunity cost though. Could you have invested that money elsewhere for a larger return?

What is Home Equity?

Home equity is the monetary difference between what your home is worth, and what is owed on it to the bank. Unlike cash, home equity is an “illiquid asset”, which means that it can’t be readily accessed or spent.

All things equal, it’s better to hold at least some liquid assets in case of an emergency. You can use your liquid assets to relieve some of the pressure.
It’s among the reasons why conservative investors prefer making as small of a down payment as possible.

When you make a small down payment, you keep your cash position high. This leaves your portfolio liquid and accessible in the event of catastrophe.

I have friends who took possession of their new home and a week later the furnace and hot water heater died. Can you imagine the cost if that had to replace them AND finance the cost? It’s always a good idea to have some cash squirrelled away, just in case.

By contrast, when you make a large down payment, those monies get tied up with the bank. You can only access illiquid home equity via a refinance, or a sale of your home — and both of those options have a cost (legal and appraisal, not to mention time).

Conversely, it’s nice to make a large down payment because it lowers your monthly payment. You can see that on a mortgage calculator. But when you make a large down payment at the expense of your own liquidity, you put your finances at risk.

Conservative investors know to keep their down payments small. It’s better to be liquid when “life happens” and having access to cash is at a premium.

Interest Rates are higher for those that put 20 percent down!

Not only is it unnecessary to put 20 percent down, if you do put 20 percent down, you may actually wind up paying more for your home in the long run.

It’s hard to fathom but the new mortgage rules that came into effect in October 2016 changed things. Those with 5 per cent down will receive a better rate than those with 20% or even 25%. It all comes down to the cost of lending.

With Mortgage Default Insurance, there is less risk to the lender and the mortgage can be sold on the securitized market. If the mortgage is uninsured, it can no longer be backend/portfolio insured so the lender has to hold the loan on their balance sheet (they cannot sell uninsured mortgages on the securitized market). This means they can’t re-lend those funds so there is an opportunity cost.

For homebuyers with 20 per cent or more down, this translates into higher rates.

Buying a house: Extra Costs

First-time buyers beware!

Although your down payment is the biggest part of the overall costs of buying a home, there are other things you will need to budget for.

For instance, closing costs typically include fees for: legal fees, tax and title services, government record changes, and transfer taxes; appraisals, and surveying; inspections and certifications.

First-time home-buyers are sometimes surprised when they see how closing costs can add up. In Alberta, we don’t have land transfer tax so legal and disbursement fees will run you somewhere between $1,600-$2,000, depending on the sale price of the home and the lawyer you chose.

The appraisal is another $300-$400 and an inspection will be another $350-$700 depending on the size of the property.

And we haven’t even considered the cost of moving, setting up of utility accounts or furnishing your new home. Be prepared! It’s not all about having enough money for the down payment.

Is it better to take out a mortgage via a broker, or go it alone?

Part of the recent rise in brokered mortgages comes off the back of the new rules from last October. Many people report they liked their mortgage broker because they can often get a better rate than if they went directly to a big bank.

What’s even more obvious is the customer service, education, unbiased advice and response time to client’s questions. I’ve had many clients tell me that they’d been trying to call their bank for weeks and still had not received a call back! That’s got to be frustrating.

A good Mortgage Broker will monitor their client’s mortgage for its entire duration. They will ensure that the client is made aware of the best mortgage deals to suit their circumstances now and in the future.

An true advisor will regularly checks rates and inform their clients of any better rates and deals available, and earns the trust and confidence of any customer.

Industry knowledge comes with experience. Communication is a key attribute to any good mortgage Mortgage Broker.

If you are wondering how much you should save for your down payment or what the best way to go is, contact me and we can review of your home buying plans!