A question that many home buyers ask themselves is whether they should put 5% down or 20% on their next purchase. Should an investor take advantage of the lower down payment and keep their cash fluid? Should a first time home buyer? Which is better?
First let’s look at what the government has published regarding minimum down payments and the difference between 5% and 20% down. If the price of the home is less than $500,000 you may put down as little as 5%. If the home is over $500,000 you will need to put 10% down for the amount over $500,000. As an example, if you purchase a home for $600,000, your down payment may be 5% of $500,000 ($25,000) and 10% of the $100,000 ($10,000) making your total down payment $35,000. If you purchase a home over $1,000,000 you require 20% of the purchase price.
If you decide to put anything less than 20% down no matter the price, you will have to purchase Mortgage Default Insurance. This insurance is offered as a percentage of the loan amount and can either be paid upfront or be added to your mortgage payments over the term of your loan. As an example, if you were to purchase a home for $400,000 with 5% down ($20,000) the insurance would be a percentage of $380,000. If the insurance was 3.1% your mortgage loan insurance premium would be $11,780. If you were to add that to your mortgage, your total loan would be $391,780 ( $400,000 list price – $20,000 downpayment + $11,780 insurance).
Is it worth buying now with 5% down + mortgage default insurance or should you save until you have 20% down? The question you need to consider is, will the value of the property increase faster and by more of a dollar amount than the amount of time it will take you to save the difference between 5% now and the future 20%. It depends on your ability to save but in most cases the answer is yes, the value of the home will increase more. By trying to avoid paying the addition $10,000 or $20,000 dollars in mortgage default insurance you are missing the growth opportunity on your investment.
Remember it is not just the increase in the market value of the property that you need to consider. If you are a first time home buyer than typically you are currently renting. “Rent” is the same as saying you are paying someone else’s mortgage for them. Instead, if you buy now with 5% down you are paying off your own mortgage. Something to consider is your rent of $1000 is equal to $12,000 per year. By deciding to wait and save, what you pay in rent is usually equal to or more than what you are trying to avoid in mortgage default insurance. $1,500 a year in rent is $18,000. That $18,000 in rent could be put towards your own home. $2,000 a month in rent is $24,000 a year, which is double the amount of the mortgage default insurance premium we used in our example.
What if you are not renting? What if you are living with parents or “rent free” through some other means? Then the question becomes, where is your money best serving you? If you are putting your money in the bank while you save, what is the interest rate on that account? Are you getting a higher return than you would on a property? Historically properties in Canada have increased in value more than your typically savings account. Even when you take into consideration periods of time where the value of a home has gone down, you must remember that Real Estate is a long term investment for most. Don’t look at it year by year but rather several years by several years. Think of what your parents bought their home for many years ago.
The hardest part about Real Estate is getting into the market. Once you are in, it is easier to stay in as your property will increase in value in most cases at the same rate if not better than the market. So back to the original question of 5% down verses 20%. If you have the 20% for a down payment, great. Save yourself thousands of dollars by avoiding the Mortgage Default Insurance. If you do not have 20% but instead you have the 5%, get into the market now. Pay off your own mortgage instead of someone else’s. Don’t forget that there are several other ways to increase the value of your home as well. For more insight into Real Estate Investing, please read http://ryanligeza.com/thinking-of-investing-in-real-estate/
If you have any questions or would like to go over the numbers in more detail regarding 5% down verses 20%, please contact Ryan Ligeza.