Larger down payments reduce monthly mortgage costs but could deplete your savings, making it harder to cover home repairs or emergencies.PATRICK DOYLE/The Canadian Press
When homes are as expensive as they are in Canada, your down payment matters as much as your choice of house or condo.
Small down payments get you into the market faster, but with higher monthly costs. Larger down payments reduce those monthly costs but can deplete your savings and leave you with nothing for home repairs or emergencies. In a trade war that threatens jobs, you don’t want to take on the financial responsibility of a home without extra cash on hand.
To further complicate things, there are interest-rate considerations in setting a down payment. You can get a better rate on a mortgage when you put less than 20 per cent down – what’s known as a high-ratio mortgage – but then you’ll have to pay for mortgage default insurance. (To protect the lender, not you.)
An opportunity for a case study on calibrating a down payment was presented recently by a reader of the Carrick on Money e-mail newsletter. This reader and their spouse wondered whether they should put a minimum down payment on a home, go up to 20 per cent to avoid the cost of mortgage default insurance or deplete their savings and go bigger on the down payment. The target home price is $850,000.
Some further background: Both partners have maxed out their first home savings accounts at about $25,000 apiece. And both have more than double that amount in tax-free savings accounts and registered retirement savings plans.
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Now for some comparative costs supplied by Victor Tran, a broker with TMG The Mortgage Group. With a minimum $60,000 down payment on an $850,000 home, the total mortgage amount comes to $821,600, as it includes a $31,600 mortgage insurance premium. Monthly payments work out to $4,317.33 on a 25-year amortization, with total interest of $152,550.08 for a five-year term.
A 20-per-cent down payment of $170,000 slashes the total mortgage amount to $680,000, which means smaller monthly payments of $3,684.64. Total interest paid over a five-year term declines to $135,999.30.
The five-year fixed-rate mortgage used by Mr. Tran highlights that aforementioned, counterintuitive feature of mortgages: You get a better rate with an insured mortgage – one based on a down payment of less than 20 per cent.
The rate on an insured mortgage in this case would be 3.99 per cent, compared with 4.29 per cent for the one with a 20-per-cent down payment. Bigger down payments suggest borrowers have more financial resources, but mortgage default insurance gives lenders extra confidence that borrowers will pay what they owe.
“Based on my experience, I don’t recall a single deal where a client purposely put less than 20 per cent down to secure a slightly lower rate,” Mr. Tran wrote in e-mailed commentary on his mortgage numbers. “People don’t like paying extra ‘fees’ if they don’t have to.”
Our home-buying reader and spouse have the resources to boost their down payment beyond 20 per cent, but Mr. Tran wasn’t keen on that idea. He prefers the idea of sticking to the 20-per-cent down payment and keeping additional savings around for emergencies and investing.
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Another question raised by our reader is whether to go with a 25- or 30-year amortization. In this example, a 30-year mortgage would work out to $3,909.72 a month with the minimum down payment and $3,346.05 with a 20-per-cent down payment.
On a monthly basis, the longer amortization saves several hundred dollars. That’s big for young families, especially in a time of economic uncertainty. But the overall cost in extra interest comes in at about $100,000 or so if you assume the same interest rate for the entire 30 years of the mortgage. This applies to both the minimum and the 20-per-cent down payment.
One final query from our reader: Which accounts to use for the down payment – FHSA, TFSA or RRSP? As much as $60,000 can be withdrawn from an RRSP for a first home purchase under the federal Home Buyers’ Plan.
Mr. Tran’s sensible take: Start with the FHSA, then turn to the RRSP under the Home Buyers’ Plan. Tap non-registered investments next, if applicable. Leave the TFSA alone, if possible, for tax-free growth.
Lump-sum mortgage payments can help you become debt-free sooner by saving you interest, but need to be done as part of your overall financial plan.
The Canadian Press
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