How much to save for a down payment

So you want to buy a house. One of the first steps in the process is deciding how much you need to save for a down payment. The decision of how much money to put as a down payment will look different for everyone. It depends whether you are buying a home for yourself to live in versus purchasing real estate as an investment. Core concepts such as minimum ratios, CMHC insurance, and ROI are important when deciding on a down payment amount. Don’t fret if this sounds confusing. We will dissect exactly what impact these concepts have on your home buying process. So get comfortable while we dive into the extremely exciting world of housing down payments.

Where to start – saving for a down payment

To save for a down payment, you should decide on a target price of the house you plan to buy. This target price should take into account how much you are hoping to spend on your house. In the age of the internet, it is fairly easy to determine a target price. Websites like realtor.ca allow you to search house listings by geography, # of bedrooms, lot size, and a plethora of other criteria. Once you know which city you would like to live in, you can search for properties that fit your criteria. By using websites like realtor.ca, you will see active listings for the houses you are interested in which will help you determine how much your ideal house will cost.

Once you know roughly how much you plan to spend on your property, we can determine how much of a down payment you will need to save. In Canada, the minimum down payment percentage is five per cent of the property’s value. This means that 95 per cent of the purchase price of the home will be financed through debt, in the form of a mortgage. Having a down payment of less than 20 per cent classifies you as a high-ratio mortgage and means you will need mortgage insurance. This insurance is issued by the Canadian Mortgage and Housing Corporation (CMHC) and is used to hedge the risk to charter banks, stemming from higher-risk mortgages (under 20 per cent down payment). For example, if your target price is roughly $365,000, there is a required minimum down payment of $18,250 (five per cent). 

Five per cent versus 20 per cent 

For those looking to purchase a house to use as their primary dwelling, it is recommended you save a minimum of 20 per cent for a down payment. By saving up for a 20 per cent down payment, it will greatly reduce unneeded expenses by avoiding having to pay for mortgage insurance. Additionally, having a larger down payment means you will incur less of a loan, which will reduce the amount of interest you will pay. A higher down payment has the added benefit of making your periodic payments lower, meaning your expenses will be more manageable. If your mortgage payments work out to be too high, even after you surpass the 20 per cent mark, you may be attempting to buy a house that is out of your price range, and you will need to refine your target price before moving forward. 

Purchasing an investment property

The down payment decision looks slightly different if you are purchasing a house to rent out as an investment property. In this case, it may be justified to settle for a five per cent down payment. As a landlord, your primary concern will be how much rent you will need to charge. If your property can be rented for $1,000 a month, you will need to make a down payment decision based on which amount corresponds to monthly payments which are less than your rental income of $1,000. If you can cover all of the monthly expenses with the rental income, you may consider putting less money down.

Your return on investment (ROI) increases when you have a smaller down payment. This principle is fairly straightforward to understand. The return realized by property value increases will be consistent throughout any level of down payment. This means that your realized return on investment will be a greater percentage if you initially put less money down. To make this clearer, imagine a property whose value grows from $500,000 to $550,000 (capital gain of $50,000). If you initially put five per cent ($25,000) down, you are looking at a return on investment of 200 per cent. Compare this scenario to a 20 per cent ($100,000) down payment, where your return on investment drops to 50 per cent. You should note, however, that taking on a lower down payment does increase the risk to the landlord. The increased risk stems from covering the larger mortgage payments. If you are unable to find a tenant, this could spell bad news for the property owner.  

To wrap up… 

I hope this discussion gives you a better understanding of what to consider when making your down payment decision. The biggest take away should be how your down payment impacts your monthly expenses through your mortgage payments. We have left out the math on calculating mortgage payments. However, our team is more than happy to run a personalized calculation for you. We can explain mortgage expenses at different rates, so you can apply the information to your own unique budget.

Reach out with any questions about the home buying process!

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