Coming up with a down payment is often the biggest hurdle first-time homebuyers face. Saving up enough money can be a big challenge, and you may worry you might not have enough. If you’re starting to think about buying your first home, it’s time to get serious about figuring out how much you’ll need.
The Five Percent Minimum
Canadian law requires a minimum of five percent of the cost of the home as a down payment. For a $300,000 home, that comes out to $15,000. This is a good goal to start with. However, people sometimes run into problems when they start shopping immediately after saving up $15,000. That money will be enough if the home costs exactly $300,000 or less, but if you find something for $310,000, you have to come up with an extra $500. It’s smart to set your goal a bit higher than you think you’ll need.
A Better Standard
Of course, the more money you can put towards a down payment, the better. Most banks consider 20 percent to be the gold standard. If your down payment is at least this much, you won’t have to pay the mortgage insurance, which can add more than $10,000 to the cost of the home. Higher down payments also result in lower monthly payments.
The GDS and TDS Ratios
Banks determine loan amounts – and whether or not they’ll loan you money – using the Gross Debt Service (GDS) and Total Debt Service (TDS) ratios. The GDS represents the total cost of your home – including mortgage, homeowners’ insurance, property taxes, 50 percent of condo fees, and estimated utility payments – divided by your monthly income. Most banks require these housing costs to be less than 30 percent of the income. The TDS includes other debt you might have, such as credit cards, student loans, and car loans. When you add these things to the housing costs, the ratio should be less than 40 percent of your income.
Clearly, you can see you’re in a better position if you pay down your debt. If you’re saving up for a down payment, you need to direct some of your money toward debt as well.
As mentioned above, those who put less than 20 percent down will need their mortgages to be insured. This is what the bank uses to cover costs if you default on your loan. The lower the down payment, the more you’ll pay in mortgage insurance costs. For example, with a $300,000 purchase price, a person putting five percent down would pay $11,400 in mortgage insurance. Someone with ten percent would pay $8,370 for mortgage insurance. Those who put 20 down pay nothing at all. This should be a big incentive to try to save up that 20 percent if it’s possible.
Borrowing From Your RRSP
As a first-time homebuyer, you’re able to borrow up to $25,000 from your RRSPs for a down payment. Obviously, this is a very attractive option, especially for those who are anxious to start building some equity. Before you do this, remember you have to pay that money back within 15 years. Can you afford this monthly payment in addition to your mortgage payment? It's important to factor this in when looking at your monthly costs.
Understanding Your Monthly Payment
First-time homebuyers don’t always understand what goes into the monthly mortgage payment. This sometimes leads them to overestimate how much they can truly afford for a new home. The mortgage payment includes a principal and interest toward the mortgage, 1/12 of the annual property taxes, and 1/12 of homeowners’ insurance premium. It will also include mortgage insurance if the down payment was less than 20 percent and condo fees if you purchase a condo. Taxes and insurance typically add a couple of hundred dollars to the monthly payment, so you need to factor them in when you make your estimates.
Aside from calculating your down payment, it’s important to think about the other money you’ll need on hand when it’s time to finalize your home purchase. Closing costs, for example, will cost you a little extra and anyone wanting to buy a resale home will want to pay for a home inspection.
You’ll also have costs associated with moving. Plan carefully for these costs. Rather than thinking only about saving up for a down payment, think about saving up for the down payment and closing costs. This gives you a more realistic view of what you’re doing.
The best way to feel happy with your new home purchase is to be well-prepared. By saving up enough money, you’ll be in a good position.