When purchasing a home, sellers would typically require you to pay a down payment upfront in form of cash. In Canada the minimum down payment is 5% - 20%. Setting aside more cash for your down payment gives you more equity stake in your home, and makes the rest of the home-buying process smoother, as your monthly payments may ultimately be lower.
What does the size of down payment do to your mortgage?
1. It sets what home price you can realistically afford. Since the minimum down payment in Canada is 5% you can use this as a guide in selecting a home price you can afford. Without considering your current income and other expenditures, the maximum mortgage you can avail is:
(Down payment total $ ÷ 5% or 0.05)
For example: If you can afford a $20,000 down payment, then you can have a maximum home price of $400,000. Now you will need to take the stability of your income and debt levels to fine tune your affordability. You can use our mortgage calculator to calculate what you can afford.
2. It determines the size of your mortgage loan and your monthly payment. Of course, the greater your down payment is, the lower your overall mortgage loan will be. This also translates to less monthly installments, and interest rates you will have to settle over the entire course of your mortgage. However you must also look into opportunity costs and other payables associated with putting up you home, (such as RRSP loans and other investments for example) in order to help you arrive to a well-rounded decision.
3. It also determines how much CMHC insurance you have to pay.
Mortgage default insurance also known as CMHC insurance, protects lenders in case that a borrower fails or defaults on his mortgage. Down payments under 20% is called high-ratio mortgages, where your equity is significantly smaller than the mortgage loan, thus it requires insurance. On the other side, conventional mortgages is when the down payment is greater than 20%. The CMHC insurance premium is determined as a percentage of the home price. So, the higher your down payment is, the less calculated insurance premium is required from you.
Sourcing the Down Payment
There are a lot of ways in which you can save more money for your downpayment:
Savings from monthly pay-cheques;
Sales stocks and bonds;
Sales of personal property or inheritance;
Reaching out to family or friends;
One common source of funds is the Registered Retirement Savings Plan (RRSP) Home Buyer’s Plan (HBP) which allows first time home buyers to withdraw up to $25,000 from your RRSPs - tax-free.