During the last six years, I’ve had clients buy with as much as 100% down and as little as 0% down.
In actual fact, I’ve had clients buy with negative downpayments when “107% financing” was still available.
Buying with 5% down is very common, but should it be?
How many house or condo buyers do you think make a budget before they dive into the real estate market head-first?
How many prospective buyers do you think actually sit down and make a list of all their monthly expenses, and then compare their income and expenses with various scenarios of a $300,000, $330,000, and $350,000 potential purchase at 5%, 10%, and 15% down?
I would say about 1%.
But who cares, right?
It’s only the single, largest purchase decision that these people will have made up to this point in their lives…
I’m constantly amazed by the lack of sophistication of the people that contact me with dreams of buying their first house or condo, and I apologize in advance if you fall into this category.
If buying real estate is a ten-step process, most buyers skip the first four or five steps and just start viewing houses and condos without doing any research or preparation.
Then I become the “bad guy” when I tell them that they’re looking at a $3,300 per month carrying cost of the property they have fallen in love with, despite their $2,700 per month take-home pay.
A couple of years ago, our mortgage industry was drastically changed when “Zero-Down” mortgages were eliminated along with 40-year amortizations.
As we move forward into the next decade, there is some debate about whether it is “smart” to be buying with 5% down.
Personally, I feel that every buyer is different and only the individual him or herself can make that decision. I just hope that it is a well-thought-out decision and not one based on emotion and pretty kitchen counter-tops…
A typical $300,000, entry-level condo only requires a $15,000 downpayment when you fall into that 5% category.
But most buyers fail to realize that they’re going to need far more than this $15,000 to actually buy the condo; the 5% is just your downpayment.
You need to come up with $3,000 in Land Transfer Tax for our Province, but thankfully if you’re a first-timer, you don’t owe the City anything.
You’ll need to come up with about $1,000 (or more) for your real estate lawyer too.
Once you add in your new couch, plasma-TV, and car-full of IKEA purchases, you’re in for another $4,000.
When all is said and done, the $15,000 you ear-marked for your “downpayment” is about $10,000 short of how much you really need.
But the one number I want you to be aware of in this example is $7,838 – that is the amount of CMHC Mortgage Insurance that you have to pay for having less than a 20% downpayment. And understand that this is money you will never get back.
You could win the lottery and discharge your mortgage one month after you move in, but you won’t collect that $7,838.
Your $300,000 condo comes with a $285,000 mortgage once you put down your 5% or $15,000. BUT…your mortgage effectively becomes $292,838 once you add in this $7,838 premium. You don’t have to pay the $7,838 as a lump sum, but it does get amortized over the course of the mortgage and you can’t recover this cost.
So is it “worth” putting down only 5%?
Only YOU can make that decision. I’ve had dozens of clients purchase a home with a 5% downpayment, and not a single one has ever complained to me.
But I always recommend that you be smart with your money, and that means having a reserve.
The $300,000 condo in the above example will come with a $1254.61 monthly mortgage payment, assuming a 35-year amortization. If your maintenance fees are $350 and your taxes are $150 per month, you’re already in for $1,754.61 per month.
How much money do you take home each month?
If you take home $2,000, good luck to you.
Are you really going to live on $245 per month?
I hope you aren’t part of the “bottle service” crowd on King West…
In a perfect world, you’d only be committing 50% of your income to your living expenses, but I know this is unheard of for most people, especially the first-time buyers.
But having something in “reserve” isn’t just for today – it’s for tomorrow as well.
If the 3.99% interest rate I used in the above example goes to a mere 5.99%, suddenly you’re on the hook for $1609.11 each month instead of $1264.61 per month.
And what if something “crazy” happened like rates of 7.00% five years down the road? (still half of the average 14% rates of the 1980’s)
Make that an even $1800 per month now – plus your mortgage and taxes to cross the finish line at $2,300 per month. If you take home $2,000 per month, now you face a mortgage deficit each month.
Mommy & Daddy may be the fall back, but how freaking old are you? And is this really a long term proposition? Don’t you want to be self-sufficient?
Wait….don’t answer that. God knows how many 25 – 30 year olds I know whose parents still subsidize their lives…
So what is my verdict on this issue?
Should buyers still put down as little as 5%?
Of course they should.
It enables many people to get into the market for the first time, but this does come with risk! Before my readers quote me as saying, “People should be able to put down 5% because it helps those who aren’t otherwise qualified to buy properties that they may or may not be able to carry,” I would like to say that I agree with the 5% down scenario because I am naive enough to believe that only those buyers who have spent months crunching numbers and doing sensitivity analysis on their financial situation will end up entering the market.
I’m not a financial planner; I’m a real estate agent.
When I get involved in people’s finances, it’s time to take a step back and reassess my role.
If and when rates go up, I just hope that the first-timers have enough money in reserve to carry their properties…
fidel
at 8:52 am
I guess that depends if it’s an investment property or not… if you are renting it out, put down as little as possible
Gerrit
at 10:34 am
Totally agree. If you can’t put the 20% down, it’s not worth killing your financial flexibility by putting down more than you need to. Wouldn’t most people be better having the extra 15k (assuming it’s a 300k house) in liquid form in case they lost a job, had a medical issue etc?
My opinion is that you should have at least 10% when purchasing a home even if you decide to put down only 5.
Amber Jordan
at 1:01 pm
I earn about $2,000/month with whatever I action I can get on the side. What will that buy me big boy?
McBloggert
at 2:30 pm
“action on the side” “what’ll it buy me big boy”
Dave I think your blog just screened your first tenant! Sign her up when you find your next investment property! Demonstrated earning power and I believe the “action on the side” might be a nice, uh, un-taxed benefit?
JG
at 2:52 pm
I think it might get you a place in tent city – had it still been around. jk.
I see the 5% all the time in my line of work. Its not just the initial financial impact it has – its all those little issues down the road no one things about.
Early renewing – selling to buy another place – selling house only to realize you are stuck in the property due to all the fees associated with selling – refinancing due to emergencies – interest rates increasing. – porting the mortgage to a new property.
Putting 5% down really puts you on a tight string.
I advise a minimum down payment of at least 10%. No exceptions. But try telling that to someone who is so emotionally wrapped up with the idea of buying a house! GL.
Potato
at 5:02 am
That figure for the percentage of clients who actually make a budget/spreadsheet before buying terrifies me. Is there any correlation between that and those that have more than the minimum downpayment?
I’ve been against such small downpayments for a while. They increase the systematic risk far too much — indeed, the government recognizes that fact with mandatory mortgage insurance, but that doesn’t really remove the systematic risk, it just transfers it from the banks to taxpayer.
I’m surprised you can say that “I am naive enough to believe that only those buyers who have spent months crunching numbers and doing sensitivity analysis on their financial situation will end up entering the market.” when at the beginning of your post you recognize that not all, not most, not many, not some, not even a few people do that, but just the rare exception…
Fidel: I see the logic behind wanting to leverage investment properties, but I seriously think it shouldn’t be allowed (again, for systematic risk reasons).
JG: Another good reason against 5% down is that you can get stuck since the cost to sell is higher than 5%. Had it happen to a friend-of-a-friend: newlyweds, bought a house with 5% down, but less than 2 years in and they decide to split up. No assets other than the house, and they couldn’t sell it to walk away since they would be underwater with closing costs & CMHC premium (even with the housing market in their city up modestly in that time).
LC
at 10:37 am
With the market as it is, I’ve stopped looking at investment properties in the downtown core as I can’t make the numbers work in my favour anymore. Even with only 5% down, it’s not worth the headaches of what will most definitely be negative cash flow for quite some time.
Geoff
at 2:50 pm
Although I agree 5% down is not sufficient, I think waiting until you have 20% down – while paying rent, etc – is very very difficult. A $400,000 house would require an $80,000 downpayment then, and you still have closing costs (fixed) and repairs/furnishing (variable to a degree) to consider. In the time it takes to save that extra $30,000, your house prices might have gone up $60,000. I think saving 10% is more realistic for most singles/couples. But I also think an amortization longer than 25 years is not a good idea, and prospective buyers should look at their mortgage costs if they paid 8%. Also they should not carry any consumer debt at all, including car loans before considering home ownership.
Benjamin
at 4:30 pm
If all the buyers with 5% down stopped buying real estate in Toronto, the bottom would fall out of the market.
These are the people that would otherwise be unable to afford to get into the market place, and without them, the demand would drop off and prices would come down.
I for one welcome the “ban” on 5% downpayments.
One more step in the right direction if our goal is to NOT end up like the United States.
Geoff
at 3:02 pm
David – as a rough anecdotal info, what % of your clients put 5% down?
David Fleming
at 4:38 pm
@ Geoff
That depends.
What percentage of my ‘first-time-buyers’ put down 5%? I would say probably 25%, and that includes anything under 10% as some choose to put down 7-8%, even though they still pay the same CMHC premium as if they put down 9.99%.
I’ve only ever had 3-4 second or third time buyers put down less than 10%.
Believe it or not, I had a client who bought for $1,060,000 five years ago with 0% down.
Craig
at 2:38 pm
We bough a place last July with 5% down when we had enough to put 10-15% down, but since the house was in neglect and the “crappiest house on the nicest street” we felt we were better served in saving the other 5-10% to update/upgrade/reno the place and increase the value of it. As such, we’ve spent about $50,000 on updating the heating system, redoing the bathroom, refinishing hardwood floors, etc. In my opinion, we used the money more appropiately as we’ve increased the value of our home and we get to live in a house that is in much better shape than we bought it in.
Of course, we also did a 35 year mortgage but our plan is to live there for 5 years, build up lots of equity (homes in our area sell for abotu 200k more than we paid) and then move back to my wife’s hometown in New Brunswick and live mortgage free!
Jerry
at 8:25 am
It’s very interesting to read these comments nearly 7 years later and see the skepticism towards the housing market with what were already lofty prices that had appeared overvalued at the time. Since then, real estate prices have doubled and stock prices have soared. Does that trend continue? The only thing I know for sure is that nobody knows that answer.
Jman
at 12:50 pm
Great read i appreciate it cuz im. Looking at a 300k property rn
With hopes it will. Appreciate to maybe 5 or 600 k within the years giving it a positive equity that can maybe be used to clear the property? Or. Make other investments
Buying real estate is the biggest purchase ull everr make in ur life
But i come from a place where i UNDERSTAND VERY CLEARLY
THAT THIS ISNT A PURCHASE evrryone makes
Some. Settle
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at 4:22 pm
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