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4 Aug

Down Payments…The Ins and Outs

General

Posted by: Brent Batten

As we all know, saving up for a down payment is one of the most difficult aspects of buying a house. Let’s face it, the average person doesn’t generally have 10’s of thousands of dollars just sitting there waiting for a rainy day. So how on earth do you come up with enough and how much do you actually need? Let’s dive in.

HOW MUCH DO I NEED?

First things first, there are all sorts of misconceptions floating round about down payments these days that 5% is the magic number. You see a house that’s $600,000, grab your calculator (if you’re like me who needs a calculator for everything) and figure out what 5% is. $30,000 is what you come up with and think finally, I found the house I want, I have saved up $30,000 + an extra 1.5% of the purchase price for all the closing costs (don’t worry I’ll touch on them too!), so I’m going to go apply for my mortgage. How shocking is it when you ask your mortgage broker how much you need to have available they tell you that for the down payment you need $35,000. How can that be? You did the math, you know 5% of $600,000 is $30,000. Well…..its  because 5% isn’t the whole story. On a purchase in Canada, it’s 5% of the first $500,000 and 10% of any amount above $500,000. So in our example, let’s break it down:

5% of $500,000 = $25,000
10% of $100,000 = $10,000
Purchase Price of $600,000 = Down Payment of $35,000

So now that home you saw will have to wait a little longer until you manage to save up the extra $5,000 you weren’t expecting. That can be demoralizing, you saw the home you’ve waited for slip through your fingers. That’s why it’s important to know what kind of costs you can expect and exactly how to quickly calculate them.

WHERE CAN I GET MY DOWN PAYMENT?

This is the second most common question that we get right behind how much do I need. What money can you use for your down payment. There are lots of different policies that lenders have so without getting into each lender and their specific policy, I’ll stick to the three main ways people can come up with enough for a down payment.

  1. RSP Savings – you can withdrawal up to $35,000 tax free from your RSP’s as a first time home buyer to use for your down payment. Under the Home Buyer Plan, you don’t have to pay the withholding tax you normally would when taking money out of your RSP. You will then have 15 years to repay your RSP beginning the year following your purchase. The amount you took out is simply divided into 15 and that’s how much you are responsible for contributing back to your RSP each year. You of course can put more in and contribute as fast as possible, you don’t have to wait the 15 years.
  2. Savings – you can set aside x number of dollars from each pay cheque, from tax returns, from whatever source makes the most sense for you. It’s best to have a plan, so you know that you are going to take the money right away, put it into savings and let it accumulate. If you’re just putting a bit here and a bit there without really planning for it, it may take a significant amount of time to get to your goal!
  3. Gift – something that we see more and more is parents wanting to help their children get into the real estate market. They’ve lived through renting and know the value of owning your own home, so of course they want that for their kids. A gift can come from your immediate family, so think mom/dad, brothers/sisters, grandparents. Anyone outside your immediate family, there will have to be a very compelling reason why they are gifting the money to you and their connection to you. So let’s say you were raised by your aunt and uncle and they want to help you out, odds are high that would be acceptable. The main thing with a gift is that it must be a true gift with no expectation of repayment.

WHAT ABOUT OTHER COSTS?

The down payment isn’t the only thing that you have to save up for. The other piece is your closing costs which lenders want you to have 1.5% of the total purchase price available. So in our example of a $600,000 purchase, your closing costs would come to $9,000. Now that’s not to say you’ll spend the entire $9,000 or you’re required to, it’s just to make sure you can pay for items such as an appraisal (if required), legal costs to close, property transfer tax, title insurance to name a few.

So now that we know what closing costs could be, let’s see what your total amount needed to purchase a $600,000 home with the minimum down payment would be:

$600,000  Purchase Price
$35,000    Down Payment
$9,000      Closing Costs

So in total, you’d need $44,000 saved up, which is a long way from the $30,000 you may have initially thought. This is why you should always reach out to your mortgage broker to discuss, even if you’re not ready to buy, but just to get an idea of what costs you’ll need.