Should I Wait For A 20% Down Payment?

20Percent

I’m sick as a dog this week, so I called him some help from my mortgage broker, Joe Sammut, to write a guest blog while I drink Neo-Citron, slurp soup, and take three times as long to complete menial tasks as I sit in this foggy haze…

I was just sick this past December, with the same cold.  Are some people more susceptible to colds than others?  I feel like I get six colds per year.

At least my wife isn’t fed up with me……yet.  And how come she never gets sick, even though I always am?

Wait, wasn’t I writing a blog or something?  Oh yeah, okay, here we go…

20Percent

Should I Wait For A 20% Down Payment?
Joe Sammut
Mortgage Architects

We hear a lot of home-buyers saving aggressively nowadays in order to facilitate a large down payment on a home.

Many of them aim for the coveted 20% down payment as a means of avoiding high-ratio mortgage insurance (we’ll refer to it solely as CMHC for the purpose of this article).

Their reasoning is that there’s no need to pay a premium for borrowing money, and CMHC is just another premium. Well, that’s not exactly the case.

If someone has 19% saved and can easily push themselves to 20% then it makes perfect sense to do so. But what about people that currently only have 5%? 10%? 15%? CMHC becomes a much more feasible route at that point.

Originally, it was found that people could easily afford to carry a mortgage – the problem was that it was often difficult for families to come up with a down payment large enough to make the banks comfortable.

That’s where CMHC came into play.

They bridged the gap by allowing people to borrow up to 95% of their purchase while giving banks the security they needed in order to lend that high.

So instead of looking at CMHC as penalizing someone for not having enough of a down payment, it is more accurate to say they help people with smaller down payments that would have otherwise not been eligible for homeownership yet.

But as is always the case with mortgages, let’s talk real numbers.

Let’s imagine a client – we’ll call him Frankie Firsttimer – looking to purchase for around $700,000. Now imagine Frankie earns an annual salary of $115,000 and has enough savings to cover 10% ($70,000) plus closings costs.

Frankie wants nothing to do with CMHC as there is a stigma behind paying a premium on a mortgage so he wants to put 20% down when he purchases.

Let’s assume he can comfortably put away $1,500 per month into a savings account to bulk up his down payment.

At this rate, it will take Frankie nearly 4 years to save the remaining 10% of his down payment. In this time he may come into money through an inheritance, a raise, a return on an investment, the lottery, or some benevolent billionaire, which would all shorten his timeline.

But let’s set that aside because there will also be rent payments, unexpected vehicle expenses, vacations, etc.

Now let’s imagine another client – we’ll call her Betty Buynow – who is in the exact same position as Frankie Firsttimer but is eager to get into a home today.

Because she only has 10% down, her CMHC premium would be 2.4% of her mortgage (this is rolled into the mortgage and amortized over the life of the loan). I’ve laid it out here:

Purchase – $700,000
Down Payment – $70,000
Mortgage – $630,000
CMHC Premium (2.4%) – $15,120
Total Loan – $645,120

If Betty buys today, her mortgage payment will be $2,951 per month*. How does that compare to Frankie’s payment if he puts 20% down and avoids the premium? Let’s examine his scenario below:

Purchase – $700,000
Down Payment – $140,000
Mortgage – $560,000
CMHC Premium – $0
Total Loan – $560,000 

Frankie’s monthly payment in this scenario could be as low as $2,263** depending on how he chooses to amortize. CMHC allows for a maximum amortization of 25 years whereas a non-insured mortgage can be amortized up to 30 years.

By just looking at monthly payments, Frankie is way ahead of the game because he’s borrowed less and didn’t have to pay a premium on his mortgage – a savings of almost $700 per month.

But what about the last four years that Betty has owned a home and Frankie hasn’t?

The Toronto housing market can appreciate by 5-12% per year depending on season, month, region, and property type. Let’s go with the more modest end of things and assume Betty’s home has only gone up by 5% per year.

In the four years it’s taken Frankie to save his down payment, Betty’s home as appreciated to a market value of $893,395. She’s also paid down her mortgage by $76,570 meaning her net worth has increased by roughly $270,000 (not including her original down payment).

And as for Frankie? Well, the $700,000 home he was looking at 4 years ago has now appreciated out of his price range. So his $700,000 is going to get him less house/condo than it would have earlier. But again, let’s examine the numbers at the 4-year mark.

Betty’s situation after 4 years:

Property – $893,395

Mortgage balance – $568,547

Net worth – $324,848

 

Frankie’s situation after 4 years:

Property – $700,000

Mortgage balance – $560,000

Net worth – $140,000

If Frankie has lived with his parents all these years, the above numbers apply and that’s the end of it. But while Betty has been spending $2,951 per month in a mortgage, Frankie may very well have been spending $2,000 per month in rent without building any equity at all.

This would mean he has paid $96,000 to his landlord in that time. While this won’t affect his net worth in the end, it is money that could have been better spent.

This is, again, situational but rent should absolutely be accounted for when making decisions.

Each mortgage payment you make contributes to principal and each year you stay in your home contributes to appreciation. The above are very general examples but they perfectly illustrate the effect time can have on your biggest investment you’re possibly ever going to make. Bear in mind; over the last two decades, appreciation has reached record highs – much higher than the 5% used above – but there is no guaranteeing what the future holds.

So, should Frankie have waited?

Well, the truth is people save at different rates and they realize appreciation differently from property to property. Income, rent, expenses, preferences, and careers can all change.

But in the grand scheme of things, was waiting worth saving a few hundred dollars a month? No. Should Frankie have purchased when he had only 10%? Possibly.

But the better questions is, should he have allowed the stigma of CMHC to affect his buying decision?

Absolutely not.

He should have spoken with a professional who could have run these numbers for him and determined what sort of timeline would have worked best for his situation.

Why worry about a mortgage that is under 3% per year when your home appreciates at more than 5%?

Conversely, why take the plunge when you can live more comfortably by holding off a year or two. This article is not intended to sway you either way, but instead to make you think.

Take the time to examine these numbers. Be mindful of all factors that are going to influence your life over the next several years.

Speak to a professional. But please, don’t allow stigma to be the one thing keeping you from an incredible opportunity.

* Mortgage payments calculated at 2.69% compounded semi-annually and amortized over 25 years.

** Mortgage payment calculated at 2.69% compounded semi-annually and amortized over 30 years.

Joe Sammut, AMP, CAAMP
Mortgage Broker # M08004805
Brokerage # 10287
Mortgage Gate Corporation
1-888-575-4403 (p) ext 21
1-888-575-4404 (f)
joesammut@mortgagegate.ca
www.mortgagegate.ca

22 Comments

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  1. Ch.T says:

    Moral of the story: buy and wait… Not wait and buy.

  2. Geoff says:

    Anyone else thinking that someone making $115K and buying a $700,000 place with only $70k down is crazy town? I’m not an old foogey, I’m 40 and we bought a $450,000 place with $45K down, and made $120K. And even then it wasn’t easy.

    1. Appraiser says:

      @Geoff. It’s all proportional and it’s all about debt-service, which of course is based on prevailing interest rates. No one said it was easy, but I bet that the vast majority of homeowners are very happy with their decision to buy.

    2. condodweller says:

      @Geoff It is crazy if you are conservative like me and it’s not if you believe house prices will continue to rise forever and you don’t want to do anything else in your free time because all your money is going towards servicing your debt.

      Then again I always say to be wealthy you have to take short term pain over long term gain. Like anything else, you have to make a decision you are comfortable with. Just don’t let the industry talk you into doing something you don’t want to do. Stephen Spielberg is going to come after me for royalties if I keep using this line: Just because you could, doesn’t mean you should. I removed the quotes because the actual line in the movie is something like they never stopped to think whether they should. Anyways, that’s one of my favourite principles I live by and it has served me well over the long term.

    3. Kyle says:

      Excellent post Joe.

      Everyone has their own personal risk tolerance, to some people buying 700K, with a 10% down and 115K salary seems ludicrous, to others paying 2,951/month or 30% of a 115K salary is perfectly sensible. At the end of the day these come down to one’s personal comfort level. The real point of the post however is to do the math and then make a decision based on real numbers, which is something i don’t think anyone here would argue with.

      1. Paully says:

        @Kyle, well said!

  3. Appraiser says:

    Great article Joe. The following will help to illustrate your thesis.

    TREB January data is out today. Year over year stats are as follows:

    Sales are up 8.2 per cent and average prices are up 14.1 per cent! (good luck thinking that you can save faster than the market).

    P.S. New listings are down 6.1% and total active listings are down 14.1% vs. last January. Therefore upward price pressure continues to be strong.

  4. GinaTO says:

    “CMHC allows for a maximum amortization of 25 years whereas a non-insured mortgage can be amortized up to 30 years.”

    I learned something right there – didn’t understand why I kept hearing that amortizations were now capped at 25 years, when mine is 30 years – I put more than 20% down. Now I understand!

    And, David: wait ’till your (future) kids go to daycare. I’m always more sick than my husband, but since my son started daycare a year ago, OH BOY. I’ve never been so sick, so often (pink eye three times in December, anyone??) But it’s all worth it 🙂

    1. Johnson Smith says:

      Nanny instead then?I realize it costs more….

      Maybe people putting 10% down on 700, 800k houses should re-evaluate their priorities if they have young children and want different types of child care.

  5. Paully says:

    Why rent and pay your landlord’s mortgage, when you can buy and pay your banker’s/broker’s mortgage instead?

    1. Appraiser says:

      @Paully – Because rent never ends but mortgages do.

      1. Boris says:

        not really as we are all debt serfs.

        Once people pay down to x% of a mortgage, it seems like they just cant help themselves into releveraging into a larger house.

        1. Appraiser says:

          @ Boris: Over 40% of Canadian homeowners are mortgage-free.

          1. Boris says:

            And 26% w a mortgage spent morre than 30% of household income on mortgage payments. That is 1.4mm households.

            It is scary that we’re at 167% on household debt to disposable income, and that household credit is now 1.87 Trillion = 95% of GDP and >100% of real time GDP.

          2. condodweller says:

            @Appraiser How many of those 40% don’t have a HELOC attached and if they do, how many have a 0 balance?

        2. condodweller says:

          @Boris Exactly. I know several people whose mortgage is at least double the original purchase price of their house!

      2. condodweller says:

        @Appraiser So you favour renting because it never ends? You gotta work on that comprehension issue in 2016 🙂

  6. Marina says:

    Many people can’t out save the market. By the time you save the 20%, it’s become only 15% for the same house.

    We bought 5 years ago with 10% down on a 650k house. If we tried to save up to 20 %, it would have taken 3 years, but by then we would have needed an extra 30K to get 20% of the new value. It’s just a never ending cycle.

    1. Fro Jo says:

      The cycle may end some day, which is why I wouldn’t frame the advice in such objective terms. Congratulations on your good fortune, though.

  7. TL says:

    This is mostly true. However, there are tons of other costs that come with home ownership such as property tax, higher utility bills, insurance, repairs…etc. Renting for life is not a bad option.

    1. Dennis Erickson says:

      Hint: If you think you are not paying for taxes, insurance and repairs when you rent, you need to ask your landlord where your rent money goes. You are pay HIS expenses for sure, but you ARE paying them in the form of rent increases, no tax relief, no appreciation, no debt reduction etc. Keep renting but remember, you are buying a home, just not for you.

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