Should I borrow money for my down payment?September 13, 2012
Buying a house is a big investment and one that you may not be prepared for. What do you do if you don’t have a down payment handy? There are pretty much two options: wait and save, or borrow. But is borrowing a down payment a good idea? Let’s find out:
First, let’s address the savings route. Saving a down payment is an excellent idea, but it takes time and patience. Even if you wanted to wait a year to save up a $5000 down payment you would have to commit about $420 per month to savings – can you save that much? If you can then this may be the better route.
If you do choose to save it’s a good idea to open a Tax Free Savings Account (TFSA) to put your cash, as it will grow tax free until you are ready to withdraw it. Also ensure that you choose a safe, short-term investment that won’t be affected by market volatility, such as a GIC or bond.
If you don’t have a minimum of 5% to pay down on a mortgage then your options are to borrow from someone you know, or from an institution. The money can be borrowed from any institution – it doesn’t have to be the same one you are getting your mortgage through, and it can be virtually any type of loan such as a line of credit or unsecured loan.
So what’s the downside? For one, you do have to repay that loan amount, while making regular mortgage payments. Since lines of credit typically come with a higher rate than mortgage rates you are going to have to spend more money servicing your mortgage and loan every month than if you had waited to save up for a down payment. If you borrowed from friends or family you need to pay them back too, or get used to some awkward family gatherings and barbeques.
Whether you choose to save for your down payment or borrow, having less than 20% down payment means you will be required to take out CHMC insurance. This will cost around 2.9% of your total loan amount, which basically means you are adding nearly 3% to the cost of your mortgage. This may not seem like much, but over the long term it adds up. If you are self-employed (without 3rd party income validation) then you must come up with a minimum 10% down payment and still pay 4.75% CHMC insurance. So obviously it can save you a lot of money to come up with a larger down payment.
For mortgage amounts of 95% of the purchase price you need to have a decent credit rating of at least 650 via Equifax. Even at 650 you may still be subject to higher Canadian mortgage rates than if your credit score was over 700, so keep this in mind.
There are a few other options to borrow a down payment if you have funds that are not accessible. An RRSP or secured loan (using your investments as security) can provide you with a low-interest loan without having to dip into your savings.
You could also drum up cash in other ways: take on a second job for a few months, get rid of a vehicle and switch to transit, etc. All of these little things add up and could result in a sufficient down payment in just a year. If you have cash, but not enough, this is definitely an option, or you could start looking now for a smaller place with a more serviceable mortgage now and plan to upgrade a few years down the road when you’ve had a chance to save more. Don’t despair, there are many options available, you just need to find the one that works for you.