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How Much Down Payment Do I Need?

retro drawing of money exchanging hands

Down payment size is a constant question among homebuyers. Many assume, “bigger is better.”

But is it? If you have a wad of cash that you could put down on a house—perhaps from the sale of an existing home—should you?

Below we consider the options. We take a look at the pros and cons of common down payment sizes and weigh the economic pros and cons of each.

5 Percent Down

Pros:

  • This is the least amount of capital required to become a homeowner in Canada
  • At the risk of stating the obvious, 5 percent can be saved far more quickly than, say, a 20 percent down payment.
    • If we only had a dollar for every prospective young homebuyer that spent years saving for a larger down payment, only to see home prices soar and move their goalposts further away.
  • It allows those with minimal assets to get themselves on a forced savings plan quicker, thus potentially building tax-free home equity faster (tax-free if you sell and claim the principal residence exemption).
  • The best mortgage rates are generally reserved for high-ratio, insured mortgages (i.e. those with less than 20 percent down).
  • Purchasing with 5 percent down means the buyer can participate in the government’s recently launched First Time Home Buyer Incentive, as well as other governmental home subsidies.
  • As noted above, putting less down leaves more cash for other purposes, such as investing, post-secondary education, home improvements or emergency fund building.
    • Many don’t realize it, but you can actually borrow your 5% down payment (so long as that loan payment is included in your debt ratio calculations).
    • While strongly discouraged, some even put their down payment on their credit card.

Cons:

  • Putting the minimum down would entail a 4 percent default insurance premium (it can be rolled into the mortgage, however).
  • Starting with just 5 percent equity in your home raises the risk you end up with negative equity (i.e. your mortgage is worth more than your home) should prices fall.
    • On day one of the mortgage, a buyer with 5 percent down is nearly 99% financed when all other costs, such as the above-noted insurance premium, are factored in.
  • Results in higher interest expense due to a larger mortgage size.
  • $500,000 is the maximum purchase price with 5 percent down.

10% Down

Pros:

  • Same as above, plus...
  • Requires a lower default-insurance premium (3.1 percent instead of 4 percent).
  • Lets you buy a more expensive home (even a 7.5 percent down payment, for example, makes a $999,999.99 purchase price possible).
  • Increases the chance you'll be able to refinance at the end of your 5-year fixed term (refis generally require 80 percent LTV or less).

Cons:

  • The default-insurance premium is still costly at 3.1 percent.
  • Your purchase price is capped at $1 million, your amortization is limited to 25 years and the property cannot be a non-owner-occupied rental property.

20%+ Down

Pros:

  • Lets you avoid default insurance premiums altogether, which can save you thousands.
  • Makes it possible to purchase a home over $1 million.
  • Allows for amortizations over 25 years.
  • Available on refinance mortgages.
  • Gives you more product choices: readvanceable mortgages, standalone Home Equity Lines of Credit (HELOCs), interest-only mortgages, non-prime financing, etc.
  • Qualifies you for a much wider array of private financing.
  • Allows you to buy a 2-4 unit non-owner-occupied rental property with default insurance (which lenders will often pay, instead of you the borrower).

Cons:

  • Ties up more capital, which entails opportunity costs (i.e. you can’t invest that money for a higher return).
  • You’re often subject to the stricter uninsured mortgage stress test
    • The stress test rate you must afford equals the greater of the benchmark rate or your contract rate + 200 basis points.
    • By contrast, the insured stress test is just the benchmark rate.

35 percent (plus) Down

Pros:

  • Same as above, plus...
  • It qualifies you for the lowest low-ratio rates (a.k.a. insurable rates) if you meet the standard insurance criteria.
  • It opens up many more "non-conforming" product types, including higher-risk stated income mortgages, equity mortgages, a broader array of non-resident mortgages, and more.
  • More peace of mind that you have plenty of equity to refinance if you ever had to.

Cons:

  • Same as 20 percent (plus) down, per above.
  • Even more opportunity cost of capital.

Other Considerations

As you can see, whether you make the minimum down payment or much more, there are always positives and negatives.

Your five-year life goals, financial objectives, career prospects and countless other factors will dictate what makes the most sense to you.

One thing is certain, however. The size of your down payment should never be determined simply by the amount of free cash you have on hand. The wisest strategy is always deploying your capital to its best use. That often means investing it instead of shrinking your mortgage size.

When to Put Less Down

You can often put capital to work more effectively than rushing to pay off your mortgage. It’s often preferable to diversify away from your mortgage and invest in an RRSP, TFSA, your own business or in paying down higher-cost debt, depending on your circumstances.

If you have a high annual salary and little money socked away, that may be especially true since you can more easily handle the higher monthly payments.

When to Put More Down

If your mortgage rate is 3 percent and your tax bracket is 40 percent, you need a 5 percent pre-tax return to compete with “investing” your free cash flow in a mortgage. A comfortable 5 percent return is not always easy to find, especially considering that mortgage payments are almost risk-free.

Putting more down may also be worthwhile for those with ample money saved up but a modest annual income. That way they end up with a smaller mortgage and more manageable monthly payments. This approach is safest when the borrower has cash reserves to fall back on or a readvanceable mortgage that lets one re-borrow from a line of credit (without re-applying) in case of an emergency.