Whether it's your first or fifth home, purchasing a house is a significant milestone in your life. Like many large expenditures in the financial journey of an average Canadian, the decision to purchase a home comes with several financial concerns to consider, the two most important of which are your mortgage and your mortgage down payment.
Before we get into the main topic of the blog, i.e., mortgage down payment, let's first review the concept of mortgage.
What Is a Mortgage?
A mortgage is a long-term loan for a house that is often provided by a major financial organization. It is secured by the property on which it is taken out.
Common Mortgage Terms and Conditions
When a person obtains a mortgage loan, they are referred to as the "mortgagor" in the mortgage papers. In the same papers, the lending party is referred to as the "mortgagee".
A mortgagor is responsible for making periodic payments to the mortgagee or lender under the terms of a mortgage. Mortgage payments, which are normally paid monthly, cover the interest on the loan as well as a portion of the debt (i.e., the amount of the loan). If the mortgagee fails to repay the loan on time, the mortgagee has the right to repossess the property.
How Does the Lender Use Your Mortgage Payment?
When you make a mortgage payment, the lender immediately uses it to cover the interest. The rest of the money goes to pay off the loan's principal and, in some cases, property taxes and insurance.
Note: In Canada, your property taxes are based on the following factors:
- The budget of the municipality in which your property is
- The assessed value of your property
- The relative value of your property compared to other properties in your area
At first, just a small portion of your mortgage payment goes to the principal, but as time passes, more of the payment is applied to the principal until it is completely paid off. Your equity in the property is the portion of it that you have paid for with a down payment and mortgage payments.
What Is a Mortgage Down Payment?
A mortgage down payment is the money you save and put down toward the total purchase price of your house.
The mortgage down payment is subtracted from the total purchase price of the house, making the mortgage amount equal to the total purchase price of the house minus the down payment.
In Canada, a variety of factors could influence the size of the mortgage down payment, but lenders, here, typically require 20% of the total purchase price of the home (though this can sometimes be as low as 5%) as the mortgage down payment.
If you can, save close to or more than the minimum 20%, as this can eliminate the requirement for mortgage insurance, aka CMHC Insurance, lowering the total cost of your mortgage over time.
Is It a Must to Make a Mortgage Down Payment?
Currently, it depends on the terms of your mortgage provider because, in recent years, some mortgage providers in Canada have introduced mortgage options with which you can purchase your home with a zero-down payment.
However, generally, a down payment of between 10% and 20% of the home's cost is required by mortgage providers in Canada.
Why?
A down payment is usually required to establish your creditworthiness in the eyes of the mortgage provider. It informs the lender that you are likely to be responsible with their money.
Your mortgage down payment also prevents the mortgagee from lending out the full value of your home, giving the mortgagee a greater chance of recovering its money if you fail to repay your loan.
Why Should You Have A Down Payment?
As previously said, a down payment shows that you are financially prepared and responsible enough to purchase a property. Saving for a down payment demonstrates to yourself and the bank that you are willing to make those sacrifices. In many scenarios, your mortgage will be more than your rent, so your capacity to save shows that you are prepared for the increase.
Another reason for having a down payment is to protect yourself if you need to relocate and the housing market has fallen. Many people are unable to sell their homes because they were purchased with no down payment at the peak of the housing market, and they now owe more than the house is worth. There is no way out of this situation gracefully. You will either lose a lot of money, damage your credit, or do both.
Many individuals in that predicament are clinging to their houses in the hope that their condition will improve. A down payment will not totally prevent this from occurring to you, but it will provide you with a good cushion against a downturn. Unless your home's value drops by more than 20%, you'll be significantly better off since you began with some equity.
What Should the Size of Your Mortgage Down Payment Be?
Although a 20% down payment is the industry norm in Canada, it is not mandatory.
The absolute value of a mortgage down payment in Canada is determined by the cost of housing in that particular region of Canada where you want to buy your home.
If you are seeking to purchase in a less costly region, the down payment will be significantly smaller.
Furthermore, if you do not have the funds, you may only put down 5% of the entire purchase price. However, if you want to make a down payment of less than 20% of the entire purchase price, the lender will need you to obtain mortgage insurance.
What is Mortgage Insurance?
Mortgage insurance protects the lender, not you, in the event that you are unable to make your mortgage payments and default. You may pay for the insurance beforehand or add it to your mortgage balance. Most of the time, mortgage insurance costs between 0.6% and 4.5% of the mortgage balance. An estimate of the value of a mortgage insurance amount in Canada can be made using the following table:
| Mortgage Amount | Mortgage Default Insurance Cost |
|---|---|
up to 80% | 0.00% of mortgage amount |
up to 85% | 2.80% of mortgage amount |
up to 90% | 3.10% of mortgage amount |
up to 95% | 4.00% of mortgage amount |
In Canada, this insurance is usually offered by one of the following Institutions:
- The Canada Mortgage and Housing Corporation (CMHC) — the largest provider of mortgage default insurance (pdf) in Canada.
- Genworth —A Private Insurer
- Canada Guaranty — A Private Insurer
Why Does the Lender Ask for Mortgage Insurance Even If You Have 20% or More as a Down Payment?
You may be required to get mortgage insurance even if you put down a 20% deposit on your house. This might happen if you are self-employed in Canada with a fluctuating monthly income, have a bad credit history, or are subject to other conditions that make you a risky borrower in Canada.
It's also possible that you'll have to pay as much as 35% of the total cost of the house as a down payment. A larger down payment, like more than 35% of the total purchase price, may be needed if you do not have a minimum of two years of in-country job history.
What Should Be the Minimum Down Payment on the Total Purchase?
The minimal amount varies depending on the entire cost of your house. The chart below will give you an idea of how to estimate the minimal down payment on the entire purchase of a residential property.
| Total Purchase Price (TPP) | Minimum Down Payment |
|---|---|
TPP < $500,000 | 5% of the TPP |
$500,000 < TPP < $1 million | 5% of the first $500,000 + 10% of the remaining balance |
TPP more than or equal to $1 million | 20% of the TPP |
What Effect Does Your Down Payment Have on the Type of Mortgage Rate?
The size of your down payment impacts whether you will get a conventional or a high-ratio mortgage in Canada. You may be required to obtain mortgage default insurance if you have a high-ratio mortgage.
If your down payment is at least 20% of the value of the home, you can get a conventional mortgage or a low-ratio mortgage.
If you put down less than 20%, you'll have a high-ratio mortgage that needs mortgage insurance.
Why Do High-Ratio Mortgages Require Mortgage Insurance?
A high-ratio mortgage is considered a greater risk by lenders because homeowners who purchase at the top of their budgets and have less equity are more likely to default on their loan. As a result, mortgage default insurance is necessary for high-ratio mortgages. If the borrower can't make their mortgage payments, this insurance protects the lender's money.
How Much Will You Actually Pay for a High-Ratio Mortgage?
According to the CMHC's rates calculator, a buyer purchasing a $500,000 house with a $25,000 (5 percent) down payment and amortized over 25 years would be required to pay an extra 4% or $19,000, in insurance premiums over the life of the mortgage.
Increasing the down payment to $50,000 (10%) would cut premiums to 3.10% of the entire mortgage cost, totaling $13,950 over the life of the mortgage - a $5,050 difference. Of course, putting down the full 20% ($100,000) would eliminate this extra fee from monthly payments entirely.
If you have any further questions about mortgage down payments, please contact us. Our mortgage advisors would be thrilled to help you get the home of your dreams.