We’ve all had it drummed into our brains: 20 per cent is the ideal amount to save for a down payment.
But is it really?
Most personal finance experts say that borrowing no more than 80 per cent of your property’s purchase price is the best choice because you avoid mortgage default insurance, minimize interest-rate risk, and pass the new stress-test easier.
But there are also a few downsides that are rarely discussed. First, time spent saving up such a hefty amount may price you out of the market. Second, there’s the opportunity cost — could your money grow better elsewhere?
Of course, some have little choice — a 20 per cent down payment is required for homes $1 million or more.
But the average home in Canada is $455,000, according to the latest data from the Canadian Real Estate Association, and if you live outside of Vancouver or Toronto, the average price drops to just $360,000.
That means a lower down payment is possible for the average property in Canada.
Let’s examine why you might consider putting down a smaller deposit.
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$455,000 amortized at 3.24 per cent 5-year fixed over 25 years:
- 5% — $22,750; mortgage $2,180; insurance $17,300; PST $1,383
- 10% — $45,500; mortgage $2,050; insurance $12,700; PST; $1,016
- 20% — : $91,000; mortgage $1,770
Time is money
It might be better to jump into the market now if housing prices in your area are rapidly rising. Think of how long it took you to save the first five or 10% — by the time you save up the rest, prices may have risen so much that your monthly payments are hundreds more than they would have been a year or two earlier with less money down.
Don’t worry too much about mortgage insurance. Although it’s a big expense, and you have to pay PST on it up front, it gets rolled into your mortgage so it shouldn’t impede your cash flow too much.
Plus, it’s fairly easy to offset — just search for the lowest mortgage rate you can find — even slicing a quarter percentage point off a rate should do it.
For example: mortgage insurance with five per cent down adds roughly $100 to your monthly payment. But negotiating your mortgage rate from 3.59 to 3.24% saves you $83 a month.
Debt makes the world go ‘round
On that note, most mortgage advice is a hangup from times when rates were high — really high. Rates peaked at 18% in 1982 and bounced between 6-15% over the next two decades, until the great recession. In 2009, the Bank of Canada dropped rates below 5% for the first time in 60 years in an attempt to stimulate the economy. Rates are now at near-historic lows and can be found for as low as 3.24%.
For most of the last century it made sense to put down as much as possible to avoid inflated monthly payments, and because it was so hard to find a higher-returning investment. But when borrowing is this cheap, not only are monthly payments more manageable, but it’s fairly easier to find stable. higher-returning investments.
Debt is not inherently bad — think of what our world would look like if we couldn’t borrow money to reach our goals. We’d have few social programs, no start-up culture and minimal scientific innovation. Debt, when cheap and properly deployed, is an excellent tool to help increase living standards and grow your wealth.
So why not consider taking advantage of this unique moment in history?
The opportunity cost of 20% down
Why miss the opportunity to take a chunk of funds that would have gone into a single asset — a house, and instead put it into a low-to-medium risk dividend-paying stock?
A house you live in is not in itself an investment — when most Canadians actually add up the cost of their monthly mortgage, interest, utilities, land transfer tax, lawyer fees, and maintenance, they often find they’ve made far less upon selling than they’d thought.
Of course, there are exceptions, like in the runaway Vancouver and Toronto markets over the last decade, but it’s generally better to think of a house as a purchase, or a forced saving plan.
Not only is your cash more liquid in stock, but it also diversifies your assets, so all your money isn’t trapped and dependent on the bricks of your house.
But you can go even one-step further: a more sophisticated strategy is to use the dividends from your capital investment to help pay off the new increase in your mortgage payments.
It’s something worth considering if you can find an investment a few percentage points above your contracted rates, and if you have the temperament for this kind of strategy.
Here’s the math of how it works:
You’d save $45,500 by putting down 10% instead of 20% and your monthly payment then increases by $280.
Let’s say you invest that $45,500 in a stock that pays a 5% dividend — your annual income increases by $2275, or $190 per month. You then put that dividend towards your additional mortgage costs, leaving your monthly payment just $90 more than had you put down the original 20%.
At the same time, you’re benefiting from any potential stock price increase. And if the stock price takes a nosedive, that’s okay too, because the right company is likely to keep paying out a dividend.
Ironically, some of the best, highest-paying dividend stocks are real estate investment trusts. Renewable energy and utility companies are also worth looking into.
Ultimately, it’s important to recognize that the standard 20% down payment advice has its own risks, and you need to run the numbers for your specific situation to see what works for you.
DISCLAIMER: This article is for informative purposes only. Consult a mortgage broker to determine your best mortgage options and a fee-only financial advisor to discuss your overall financial strategy.