For many, scrounging up the required down payment is the most challenging part of homebuying.
That’s especially true for first-time buyers who can’t count on the proceeds of a previous home sale.
For those having trouble securing down payment funds, it may be tempting to ask a family member for a loan, or transfer money from a line of credit or—worse yet—a credit card.
But one thing many overlook is that lenders all want to know where your money came from. And they almost always ask for proof.
The following is a list of common down payment sources for homebuyers, and the proof lenders typically require so they can ensure the money source meets lender and legal guidelines.
1. Personal Savings and Investments: 33%
This is typically the number one source of funds for homebuyers, with roughly one third of them using personal savings for their down payment. These funds are sometimes the result of years of sweat, financial self-control and sacrifice.
Personal savings often sit in a low-interest savings account, or sometimes in a Tax-Free Savings Account (TFSA) where the money is invested in low-risk securities, waiting until the day it’s needed for a house purchase.
What most lenders require: Three months of full bank statements, showing your name, account number, transactions and balance history.
Tip: Large deposits made into your account will have to be explained and the source of funds divulged. This could be from the sale of a car, a work bonus, etc. Be sure to have supporting documentation on hand.
2. Gifted Down Payments from Family: 12%
With the rapid rise in house prices in recent years, many first-time buyers have been priced out of more competitive markets like Vancouver and Toronto.
That’s where the Bank of Mom and Dad comes in handy, especially for first-time buyers. But there are certain rules to follow when relying on the goodwill of family.
What most lenders require: A signed gift letter from the immediate family member contributing the funds. You’ll also need proof of the transfer into your bank account, in the form of bank statements documenting the money being moved from the donor’s account and into yours. Again, the statements must include your names, account numbers and the full transaction history during the time period in question. Note that if money is being received from overseas, lenders require copies of the wire transfer, and may ask for additional account history, such as statements of the foreign account(s).
Tip: A gifted down payment from a family member is just as the name suggests—a gift. There must be no expectation of the money being paid back, otherwise that would be considered a loan. Borrowed down payments are sometimes prohibited and always negatively impact your “debt service ratios.” (Debt service ratios tell the lender how much of your income is needed to cover your monthly obligations. If your debt ratios exceed lender guidelines, you won’t qualify.)
3. Loan from a Financial Institution: <15%
When you have no other option, it’s possible to supplement your down payment by borrowing the necessary funds. As you can imagine, there are restrictions on this.
Options for down payment loans include using a line of credit, a personal loan or, believe it or not, credit cards. Using a high-interest financing facility like a credit card is never advised unless there are no other options, you absolutely must buy the property or the borrowing timeframe is very short (e.g., because you’ll quickly pay off the high-interest loan with another source of funds).
Many lenders do not look favourably on people who borrow down payments from high-interest sources.
What the lender requires: Statements showing the credit facility used to supplement the down payment, and a bank statement showing the borrowed funds being moved into your account. Statements must include your name, account number and proof that sufficient unused credit is available.
Tip: Keep in mind that the lender will assign a monthly loan payment to the borrowed funds, often 3% of the amount borrowed. That will push up your debt ratios, so if your ratios are high to begin with it could keep you from qualifying for the mortgage.
4. RRSP Withdrawal: 13%
About 1-in-7 overall homebuyers (or one-quarter of first-time buyers) choose to borrow from themselves by dipping into their Registered Retirement Savings Account (RRSP).
This is permitted by the government as part of its Home Buyers’ Plan (HBP) available to first-time buyers. The HBP allows first-time buyers to borrow up to $35,000 from their RRSP tax-free as long as the money is repaid within 15 years (the minimum repayment is 15 equal instalments made once a year).
What most lenders require: A copy of the completed Home Buyers' Plan withdrawal forms (for first-time buyers). Lenders will also require bank statement verifying the funds have been withdrawn and placed into your bank account, plus three months of RRSP statements showing the funds available. Statements must show your name, account number and the funds in question. Many require the funds to have been in your RRSP account for at least 90 days.
Tip: The HBP can be an effective way to access additional funds interest- and tax-free, but the amount borrowed must be repaid within the 15-year limit or you’ll pay income tax on that year’s instalment.
5. Home Sale Proceeds: 27%
For existing homeowners, there is of course one additional source of down payment funds: the existing home. In most cases, people sell their home and source part/all of the down payment from their existing equity.
The amount of equity available depends on the sale profit and borrowing that is secured against the home. Homebuyers who have lived in strong housing markets for years often find that their homes have increased in value by hundreds of thousands of dollars. That amounts to a very nice down payment, especially if the new home is worth the same or less than the existing home.
What the lender requires: Lenders will want documentation proving what proceeds came from your home sale, such as a statement of adjustments from the lawyer, the signed sale agreement and a bank statement showing the funds being deposited into your account upon sale (if you buy your new home after your old home sells).
Don’t Count on “Mattress Funds”
Some people hoard cash “under their mattress,” so to speak. Don’t expect to use such funds for a down payment if it’s a sizeable amount. Unaccounted-for cash is usually not an accepted source of down payment funding due to the risk of fraud and money laundering.
To comply with the “Money Laundering Act,” you’ll want to deposit legitimately accumulated cash into a bank account three months before the date you plan to use it.
Plan for a Buffer
Even if you plan your required down payment amount down to the dollar, you may find that’s not enough to get mortgage approval. Many lenders also want you to have a cash buffer to cover closing costs related to your home purchase.
Lenders usually expect you to have 1.5% of your home’s purchase price set aside in cash on hand. That means if you’ve bought a $500,000 home, you should be able to prove you will have at least $7,500 in liquidity (accessible funds) to cover things like land transfer taxes, mortgage default insurance taxes, and closing expenses like legal fees. More on that here: Mortgage Closing Costs. Be Ready.
Data Citation: The stats on the top sources of down payment funds come from an Ipsos poll cited by the Toronto Regional Real Estate Board.