Homeownership is a major personal and financial goal for most young people. It’s also one of the biggest financial challenges.
With real estate prices seemingly rising endlessly in the most desirable cities in the US and Canada, it can seem impossible to get a foothold in the market. As a result, many young people panic and rush to buy before they can really afford it.
If you can’t afford to put 10% down, you can’t afford a home
Sad news everybody: if you’re scraping together 5% to put down on a home (and struggling to even come with that), you’re not ready to become a homeowner.
Homeownership is hella expensive, and this is true long after you get the keys to your new place. Virtually everyone focuses on getting together the down payment because it’s the largest upfront expense, but the ongoing costs of owning property — like repairs & maintenance, mortgage default insurance, and property taxes — can really put a damper on your long-term financial health if you’re not careful. Furthermore, there’s always the risk the value of your home will go down, and when that happens, your mortgage payment will not go down with it!
Related Post: 7 Reasons Why You Should Never Borrow Money For a Down Payment
In order to keep extra cash in your monthly budget and protect yourself from volatility in the real estate market, you need to put at least 10% down on your first home. Ideally, you’d put 20% down, but with the average house price in Canada nearly $500,000, there are very few 20- and 30-somethings with a spare six-figures lying around. A 10% down payment is enough to lower your monthly mortgage payment, reduce your mortgage default insurance, and secure enough equity in your home to whether small dips in the real estate market.
A 5% down payment gives you only 1.6% equity in your home because the rest of the cash goes to mortgage default insurance. If you put 10% down, you’ll secure 7.2% of equity in your home. In other words, saving another 5% of the house value will give you almost 6% more equity. Talk about a great return on your investment!
Save in your RRSP first, TFSA second
I’ve made the argument for saving your down-payment in your Registered Retirement Savings Plan (RRSP) instead of your Tax-Free Savings Account (TFSA) before, but fundamentally it boils down to one simple truth:
It is better to spend tax-deferred savings than tax-free savings.
The TFSA is the best retirement savings vehicle available to Canadians, but most don’t see it that way. Because the account has no rules against or penalties for withdrawals, most people use the TFSA for everything but saving for retirement. This is where they stash their vacation savings, their spending money, and, yes, their house down payments. But constantly making contributions and withdrawals from the TFSA undermines its tax-free power. You don’t need to earn tax-free interest on your vacation savings, you do need to earn it on your retirement savings.
In Canada, you can withdraw up to $35,000 from your RRSP for a down payment on your first home under the First Time Home Buyer Plan. Of course, in order to make a $35,000 withdrawal, you’ll need to actually have $35,000 in your RRSP in the first place, so start saving. Once you’ve banked $35,000 there, you can start saving the rest of your down payment in a TFSA or unregistered account.
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Cash is king
When it comes to saving up your down payment, I want you to be bored. I want the excitement of watching that account grow to rival watching paint dry. It really should be that dull. Why? Because if you’re investing your down payment money and it starts to get exciting, you’re taking on too much risk.
Your down payment isn’t about risk or growth, it’s about savings.
The stock market has been on an uncharacteristically long 8-year bull run, which has been really fun for all of us but is starting to feel like a super fun carnival ride we’re not sure will ever end and therefore is making us nauseous despite its awesomeness. Heads up: it will eventually end. And when it does, that’s the last place you want your down payment money to be.
It’s hard to put tens of thousands of dollars in a savings account returning 1% (or less), but if you want this money to put a roof over your head later, you can’t afford to take on the risk required to earn a higher return. If you’re going to be buying a home in 2 years or less, your down payment should be in a simple savings account. If your plan is to buy within 2 to 5 years, you can work GICs and super safe mutual funds into the mix. But unless you’re not planning to become a home owner for 5 years or more, stay out of the stock market.
Don’t forget to set aside extra for those added costs
Land transfer taxes, realtor fees, home inspection costs, and sales tax on your mortgage insurance can add anywhere from $5,000 to $15,000 (or more!) to the cost of buying your first home. Again, this is why a 5% down payment is NOT enough! There are so many additional costs to purchasing a home, that if you only saved enough for the 5% down payment, you’re likely going to end up thousands of dollars in debt when you finally purchase.
You’ll need to save above and beyond your down payment fund by at least 15%. This means if you need a $40,000 down payment for the property you want, you’ll need to save an extra $6,000 for possible associated closing costs.
Don’t forget new homes come with a whack of additional expenses, like moving costs and new furniture. If you’re becoming overwhelmed by the price tag of home ownership remember first that I told you so, and second, you can cut costs on moving and furniture far easier than you can cut costs on land transfer taxes. The most important thing is to be aware of what expenses are heading your way and which of them you have to take care of and which ones are avoidable, so nothing catches you by surprise.
Save consistently and wait for the right moment
It’s hard to save up a 10% down payment. It takes a lot of discipline and a lot of time. If you find it painful to sock away hundreds of dollars a month now, just remember you won’t get to ever take breaks from your mortgage. This is good practice!
Once your savings starts to inch closer and closer to your 10% down payment goal, you want to start looking at homes in your price range and watch the real estate market so you can find the right opportunity to buy. This means the right property AND the right moment.
Happy house hunting!
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There is no rush. I started saving at 18 (while going to school full-time and working part-time) and was able to put a 20% downpayment at 31 in Ottawa. Homes don’t cost nearly as much as Toronto or Vancouver, but they’re far from free. The only avantage I had was coming from a dual income home, but this has only existed 2 of the last 8 years and one of us returned to school in a different city. My BIL had to buy a house 5 years ago with less than 10% and the market value has dropped in his area…but he didn’t want to miss His chance :s Just thinking about it makes me nauseous.
Literally yes this.
I’ll post about this when all is said and done, but we put 10% ($42,500) down on our house, and probably spent close to $15K-$17K between closing costs, selling costs for my partner’s condo, new furniture, movers, cleaners, meals out, necessary appliances, etc. (I was not about to live without a washer and dryer like some kind of 1800s pauper.)
I know. It’s a horrifying amount of money. But when land transfer tax can run $3K-$5K alone it really starts to add up – and we saved and had the money ready for all of it, so we’re coming out of the whole thing with a gorgeous zero balance on all of our credit cards.
This is great. Thanks Bridget. As always, there’s so much great content here to think about.
My husband and I have been having an ongoing discussion about how to prioritize TFSA and RRSP contributions. We are currently renting, just paid off all our loans (I got inspired 17 months ago when I read your post “Pay Your F*&*ing Debt”). We are not looking to buy a home as we live in the GTA and the market is still way too hot for our taste.
One question I have about the down payment percentage: Is it bad to want to put down more than 20%? I am someone who feels like debt is an albatross and I don’t really subscribe to the idea that there’s ‘good’ and ‘bad’ debt since it’s all an obligation to someone else. If you wait longer so the down payment is bigger than 20%, what are the disadvantages (beyond the fact that you’ll have to wait longer).
It seems that in past eras, when lending was tighter and manual underwriting was the norm, people often put 50% down. Times have changed, but I personally wouldn’t want a 400k loan on my lap for a while. Cutting that by 30% sounds good to me.
I’d love to hear your thought Bridget
My husband and I also subscribe to this mentality. We put down 20% on our mortgage to avoid CMHC insurance costs. Although we rented and saved for longer, our rental costs were low enough that we were able to build other parts of our portfolio. Our experience has been saving a ton in interest costs, especially if you land a mortgage like ours where we can pay up to 20% of the original mortgage without penalty each year (or increase payments by 20% once a year). I don’t think there’s a right or wrong, but you’re not alone in your approach. I have no regrets of not over-leveraging in a questionable real estate market and building diversified assets – especially while I wait for interest rates to go crazy.
That’s awesome Katie!! It sounds like you did everything right!
haha! Pay Your F*&*ing Debt is such a great post, I’m so glad it inspired you!
Whether or not you want to put >20% down is totally up to you and how you feel about debt. From a purely financial standpoint, you’re better off investing in the stock market than putting extra on your mortgage. However, if debt really bothers you (and it sounds like it does!) from a psychological standpoint getting that weight off your back might make more sense.
I would say downsides of waiting to save more than 20% are:
– house prices may increase; this is particularly risky if they’re increasing faster than you can save
– savings would perform better in the stock market; with mortgages interest rates still <3% returns are better in the financial markets and this will remain true until/if mortgage interest rates go over 5%
- interest rates will likely increase; though Canada always says this and it never happens so who knows
At the end of the day it's still personal preference though. Not every money decision is, nor should be, about the math alone!
A nice approach is if you put 20% down and sign a mortgage that let's you make an additional lump-sum payment (usually up to 20%) each year. This way you have the flexibility to pay extra on your mortgage at the same pace you would have likely saved up an additional down payment.
Thanks for sharing this.
I have to save I disagree with this mentality. I certainly think there are indications that one cannot afford a home. I don’t think whether you put 5% or 10% is one of them. In reality, the equity one has in their home has zero to do with their financial prowess. Additionally, PMI is not paid in a lump sum and shouldn’t be added to the equation in the way you have it outlined.
I would rather put 5% down, leaving the rest in my bank, and make extra monthly payments to get rid of the PMI instead of putting a larger down payment…
If you’re buying a home within reason of what you can reasonably afford, the difference in monthly cost between 5% down and 20% isn’t really that big. In the case of the home you discussed, the difference is $20,000 out of pocket versus $40,000 out of pocket and maybe a $200 difference in mortgage payments per month….I’d rather have the extra $20,000 in the bank or invested.
Mortgages differ somewhat between the US and Canada.
In Canada, you get 25 year mortgages but the rate is only guaranteed for 5 years, not the full term. Furthermore, mortgage interest is not tax deductible.
Houses in Canada are significantly more expensive than those in the USA, with the exception of major US cities. Most Canadians live in one of the 5 largest cities in Canada. For Canada’s two largest cities, the average house price is >$1 million. Across the rest of the country, the average is still north of $500,000.
There is significant risk that Canada is in a housing bubble, which is what makes 5% down payments such a bad choice. Acquiring only 1.6% equity in your home when many global banking authorities are predicting a 20-40% housing price correction is extremely dangerous. Additionally, because mortgages must be renewed ever 5 years, if interest rates increase (which they will… eventually) most Canadians will see a $200+/mo extra cost on their mortgage then. If they’re already paying $200/mo in mortgage insurance, they will not be able to absorb this extra expense.
Finally, there has to be something to be said for reducing your overall costs of major purchases in your lifetime. Spending an extra $10,000 or $20,000 or $30,000 on mortgage default insurance just for the heck of keeping an extra $20K in the bank doesn’t really make sense. Assuming you already have an emergency fund and retirement savings, this isn’t serving you.
Another reason is the PMI, many banks will force you to get PMI if your down payment is less then 20%, some will allow you to not have to get PMI if you put down at least 10% of he home value
Not in Canada. CMHC insurance is government mandated, you can’t go without it with anything less than 20% down.