Should you borrow for your down payment?

by Jordan Lavin January 20, 2020 / No Comments

Saving for a down payment feels like it can take a lifetime. Once you factor in closing costs, like land transfer taxes, it’s no wonder half of 18-34 year olds who don’t own a home say it’s because they need more time to save.

But what if you could borrow money to make a down payment? Would it help or hinder your progress in the long run?

Canadian house prices have climbed to over $528,000 on average. That means a buyer making a standard 20% down payment would need to save more than $105,000 for an average place. Even the minimum down payment works out to a daunting $27,800, not including mortgage default insurance. That amount can be rolled into your mortgage, but the bottom line is that you need tens of thousands of dollars saved to afford an average home.

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 money you already have. The rules about where your down payment can come from are straightforward. Lenders require you to provide a minimum amount from your own resources: 5% of the purchase price up to $500,000, and 10% of the purchase price over $500,000.

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 asset, such as a loan secured by your home, RRSP, or life insurance policy, will work. However, HELOC’s are tricky 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 debt could put your purchase price out of range if you’re near the top of how much you can afford to buy.

The good news is most Canadians use their personal savings (including money saved in RRSPs and TFSAs) 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, in 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 necessarily a bad financial decision to rent your 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 ourse, interest charged on your mortgage can be considered equally as ‘wasted’ as rent payments. To avoid paying unneccessary 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. In the last year, the average home price in Canada has risen by 8.4%. With that recent history, it’s 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 inline 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 make 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.

2. Buy a less expensive home

This isn’t possibile 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 less money.

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.

4. Borrow from yourself

Another first-time home buyer program, the RRSP Home Buyers’ Plan lets you save money in your RRSP (getting tax refunds while you’re at it) then withdraw it to buy or build a home. You can withdraw up to $35,000, and any money you’ve already saved in your RRSP already counts. If you’re buying with a partner, each of you can withdraw the maximum as long as you’re both first-time home buyers. You have to pay back your withdrawal over 15 years, but that’s better than paying back a bank.

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 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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Flickr: pnwra

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