Should you borrow for your down payment?

by Jordan Lavin February 15, 2021 / No Comments

One of the toughest parts about buying a home is saving for your down payment – it can feel like it takes a lifetime! Once you factor in the additional closing costs you need to save for (land transfer taxes, for example) it’s no wonder that 50% of 18 to 34 year-olds who don’t own a home say it’s because they need more time to save.

The price of Canadian homes has skyrocketed in recent decades, even throughout the COVID-19 pandemic. In January 2021, the average Canadian house price climbed to $621,525. That means a buyer making a standard 20% down payment would need to save more than $124,305 for an average place. Even the minimum down payment works out to a daunting $31,076, not including mortgage default insurance. The bottom line is that you need tens of thousands of dollars saved to afford an average home.

But what if you could borrow money to make a down payment? Would it help or hinder your progress in the long run? Here’s what you need to know about using a line of credit for a down payment.

Can you borrow money to make a down payment?

Borrowing money to make a down payment is allowed, as long as you provide some of the down payment using the money you already have. The rules about where your down payment can come from are actually very straightforward. Simply, you must make the minimum required down payment from your own resources, after which you can top up with borrowed funds. The minimum mortgage down payment amounts in Canada are as follows:

  • For homes priced less than $500,000: 5% of the overall purchase price
  • For homes between $500,000 and $1 million: 5% of the first $500,000, then 10% of the rest
  • For homes costing $1 million or more: 20% of the overall purchase price

Secured vs unsecured lines of credit

If you’re wondering if you can use a home equity line of credit (HELOC) for a down payment, the answer is yes. Any money you borrow that’s secured by assets, such as a loan secured by your home, RRSP, or life insurance policy, will work. However, HELOC’s aren’t generally an option for first-time home buyers, as you can only get one with a minimum amount of equity in a home, typically 20%.

Using other resources, like an unsecured line of credit, is only permitted by some lenders after the minimum has been met. That is to say, once you’ve sourced the minimum down payment from savings, you may be allowed to borrow from other sources to increase your down payment. However, carrying additional debt could limit the overall amount you’re able to borrow, which could actually price you out of a home!

The good news is most Canadians use their personal savings as their primary source of down payment funds. But with mortgage rates in Canada at record-lows, it’s difficult to grow savings without taking on risk. So, is it a good idea to borrow for your down payment? Let’s look at the pros and cons.

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The upsides of borrowing money to make a down payment on a home

It’s not always a bad idea to borrow for your down payment. In fact, it can save you thousands, under the right circumstances! Here are some of the advantages.

1. Get into the Market Quicker

This is the most tempting reason to borrow for your down payment. Prices aren’t going up as fast as they once were – and in some areas, they’re declining – but with house prices still near all-time highs, borrowing can help get you into the home you want.

2. Stop Wasting Money on Rent

While it’s not always a bad financial decision to rent rather than buy a home, your monthly rent cheque is guaranteed to be gone forever. By owning your own home, every dollar you pay in principal (the portion of your mortgage that repays the loan) is a dollar you get to keep in the form of equity – assuming the value of your house doesn’t fall. Of course, the interest charged on your mortgage can be considered equally as ‘wasted’ as rent payments. To avoid paying unnecessary interest, work out how much you can spend on a home before you shop around for a mortgage.

3. Grow Your Net Worth

Many people who bought homes in the last decade hit the housing lottery, with prices rapidly increasing. This in turn contributed to fast run-ups in household net worths. Even after the coronavirus pandemic, home prices have continued to rise – Canadian house prices grew 5.4% year-over-year in January 2021. With that recent history, it makes it feel like getting into the housing market sooner could help you build wealth in the long run. The risk is that the bubble could burst, with prices dropping to be more in line with historical averages.

4. Save on Mortgage Default Insurance

When you purchase a house with less than 20% down, you’re required to pay mortgage default insurance (CMHC insurance). The premium you pay depends on the size of your down payment – rates drop as you pass the 10%, 15%, and 20% marks.

Bryan Freeman, Vice President of CanWise Financial, a brokerage owned by Ratehub, says in some situations borrowing for a down payment makes sense. For example, a secured loan source like a HELOC can increase your down payment and save thousands on CMHC insurance, lowering your monthly payments.

Purchase price $500,000 $500,000
Down payment $95,000 $100,000
Down payment % 19% 20%
Mortgage insurance $11,340 $0
Total mortgage required $416,340 $400,000
Monthly payment $1,873 $1,800

In this scenario, by borrowing $5,000 to bring the down payment up to a full 20%, you’ll save $11,340 on CMHC insurance. When you calculate your mortgage payments, you’ll find a saving of $73 a month, and a saving of $1,912 in interest over a 5-year fixed term at a rate of 2.54%.

The downsides of borrowing money to make a down payment on a home

As with all financial changes, there are risks to borrowing your down payment. Be sure to consider these points before you make a decision.

1. Repayments can be costly

If you’re borrowing from a financial institution, your down payment loan will likely be subject to a much higher interest rate than your mortgage. If you decide on a cash back mortgage to cover your down payment, your mortgage rate could be significantly higher than a conventional 5-year fixed mortgage. In this case, you’ll end up paying the higher rate on the entire balance of your mortgage.

2. Lower equity adds risk

Additional monthly debt repayments lower your cushion against surprises like unexpected repairs or a sudden job loss. Since you typically need at least 20% equity in your home to be approved for a home equity line of credit, you may have fewer options if you can’t cover your costs with savings. If house prices fall, you could also find that you owe more money for your house than what it’s worth.

3. More debt decreases affordability

When you apply for a mortgage, lenders will determine your mortgage affordability by considering (among other factors) your debt service ratio. This is the percentage of your income represented by your housing costs and other debts. Taking a loan to cover your down payment will impact your debt service ratio. The cost of paying pack your borrowed down payment could reduce the amount you can borrow for your mortgage.

4. Borrowing from family can cause other problems

Research shows 45% of first-time home buyers between 2015-2018 used gifts from family members as a source for their down payment. However, taking money from family can lead to other problems. Family politics play out differently, but tension over money is a very common cause for trouble. Further, contention over expenses like furniture or decorations can strain relationships and reduce your ability to enjoy your new home.

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Alternatives to borrowing for a down payment

If the risks outweigh the benefits, or you’re just not comfortable borrowing for a mortgage down payment, you have some other options.

1. Take more time to save

Buying a home is likely the biggest investment you’ll ever make, so there’s no need to rush it. Even when the future seems far off, taking more time to save can help you afford the home you want, while avoiding getting stuck in a financial quagmire. You’ll generally be able to save more money while renting than if you owned a home, so taking another year or two to save often makes financial sense.

2. Buy a less expensive home

This isn’t possible in some markets, but you may need to make concessions in order to afford your first home. Choosing a home that’s smaller, older, or in a more affordable neighbourhood can help you get into the market for a lot less.

3. Take advantage of programs for first-time home buyers

There are some great government incentives for first-time home buyers that can make it easier to save a sufficient down payment without borrowing. For example, the First-home Buyers’ Tax Credit pays you $750 in the year after you buy a home. There are also land transfer tax rebates available to first-time home buyers in some provinces.

4. Borrow from your RRSP

Another first-time home buyer program, the RRSP Home Buyers’ Plan, lets you use tax-deferred funds from your RRSP toward your down payment. You can withdraw up to $35,000 ($70,000 for couples), as long as the money has been in the fund for at least 90 days. You will have to pay back your withdrawal over 15 years, or you will face penalties.

Can I borrow money for a house deposit?

Not to be confused with a down payment, a deposit is the money you submit to the sellers when you make an offer to buy their property. The size of the deposit is negotiable between you and the seller, and you are allowed to borrow money to make a deposit. The caveat is that your deposit constitutes part of your down payment. You’ll still need to provide the minimum down payment from your existing assets or show you can pay back the money you borrowed for the deposit before the sale closes.

The bottom line

While there are advantages and disadvantages to borrowing for a down payment, the answer comes down to your budget and comfort level. If you’re confident you can afford additional monthly payments while staying prepared for unexpected expenses, then borrowing money for a down payment may be a good option. If you’re not comfortable making extra payments to the bank (or to mom and dad), then saving up the old-fashioned way might be the best option.

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