The great debate: Do you take your not-so-big downpayment and buy what you can (e.g. small investment condo) OR wait and save, save, save for your dream unit?
Today I come to you with a total breakdown (the numbers, pros/cons and mortgaging options) so the big decision can be an educated one, wether you choose to get ‘into the market’ or create an aggressive saving strategy.
Getting a mortgage sooner means you can start building equity, stop paying your landlord’s mortgage and take advantage of appreciation. This one decision can have a massive impact on a whole slew of other numbers that aren’t always immediately apparent.
On the other hand, saving up is always a good idea; the question is, how much do you need to save for it to make a real difference? Additionally, where will waiting actually begin to hurt your bottom line vs. help? It’s a lot of information, but I think we can get through it.
To begin, allow me to give a basic explanation of mortgages.
WHAT IS A MORTGAGE?
When you want to buy property, yet do not have the ability to buy in cash, you’re most certainly taking a mortgage. A mortgage is actually the Bank putting up the majority of the price of the house, while you put up a smaller portion and sign a contract saying you’ll pay the bank back. Your smaller portion is the down payment.
If you could afford the entire property at once, you would spend the least amount of money, no question. However, this isn’t an option for 99% of us. So – we go the down payment route, with the intention of making the bank’s money work for us.
WHAT IS A DOWN PAYMENT?
Typically a downpayment can be anywhere from 20% all the way down to 5%. Getting in now with a 5% downpayment means you’re in the market, enjoying the benefits of appreciation, equity build-up and no longer having your hard-earned cash make someone else rich.
However, although you are paying ASAP, it also means that along with interest, you’re paying much more after the amortization period (this is the length of time you’ve agreed to have the mortgage paid off – typically 25, 30 or 35-year increments). During this time period, the interest compounds and at first, the amount you’re paying toward the actual cost of the home each month (known as the principle) will be tiny because most of your payment will be going to the interest rate.
There is also another cost to buying sooner with less than 20% down and that is CMHC fees.
WHAT ARE CMHC FEES?
CMHC fees are insurance for lenders (the bank) in case the borrower (you) defaults on the mortgage payments. Every mortgage with a downpayment between 5-19.99% has the CMHC fees attached by law. The fees can cost you anywhere between 2.8-4% of the total purchase price of your property – which is no small fee.
However, in the long run it may be less of a problem than you think.
If you start with a healthier downpayment (say 20% or more) the monthly payments will be less and, after however many years, you’d have the option to transfer to a shorter amortization, saving some interest (in theory, you’d be making more money over the term of your mortgage and can accelerate payments).
Here’s one more thing we have to keep in mind:
- If the home you’re purchasing is $500,000 or under, 5% is the minimum down payment.
- If the home is between $500,000 and $999,999 than the minimum is 5% for the first $500,000 and 10% of anything above that.
- Lastly, any home that is $1 Million or higher has a minimum down payment of 20%.
In addition, interest rates tend to increase (historically, today’s rates are on the lower-end) along with the price of a home today vs. the price when you’ve finally saved that down payment. Over time, housing prices will rise even if there is a ‘dip’ in the market as the value of money decreases – think about how much it costs to ride the TTC today, versus 5 years ago, it’s inevitable.
Let’s look at an example.
Example #1: When you choose to buy with a smaller downpayment.
Let’s say we found the perfect condo downtown and it’s worth $600,000. You want it as soon as possible, but you don’t have a large downpayment. You’re able to come up with the 5% minimum downpayment for the first $500,000 and the 10% of the next $100,000, and you decide to pay it off over 25 years.
First of all, 5% of $500,000 is $25,000 and 10% of $100,000 is $10,000, for a total downpayment of $35,000.
Once you’ve paid this to the bank, your principal (the original sum of money borrowed in a loan) is $565,000. with a 25 year amortization period, that means CMHC fees will be $22,600 (approx. 4% of your home’s value), bringing your principal back up to $587,600.
Now, over that same amortization, we have to calculate interest. We’re going to go with an average of 3.5% for the sake of example.
Your $587,600 will cost you $2,941.66 every month, and after 25 years you will have paid $294,898 towards interest alone. That’s a total (after interest, CMHC fees and the minimum downpayment over 25 years) of $882,498.
Yes, it is a lot, and also quite typical. With the amount of money we have to borrow, and the way banks work, interest rates and ballooning mortgages are unfortunately the reality.
This might look like two steps forward, one step back but allow me to give you one more example, and you’ll see that the obvious choice may not be the best ones for you.
Example #2: You’ve waited to save-up a large downpayment.
For this next example, let’s look at this 5 years from now, say when you’ve managed to save 20% of the down payment.
With a 20% down payment or higher, you manage to avoid CMHC fees altogether, which is nice. Here’s the kicker – your $600,000 home in 2019 is worth $841,531 in 2024, or $241,531 more than it would cost you today.
This is calculated at an average home value appreciation of 7%. Disclaimer: we do not have a crystal ball and this is an educated guess at best. However with downtown condos appreciated on average 10% year-over-year and Toronto experiencing continued growth, it’s not an unrealistic assertion.
Keep in mind, 20% of $600,000 was $120,000. 20% of 841,531 is $168,306. This means your principal, to be paid over 25 years, at an interest rate of (for example purposes) 4%, will be (total home value minus the down payment) $673,225.
This is $3553.35 monthly, with a total interest $392,834 paid over the amortization period.
That’s a total price of $1,066,059 at the end of 25 years.
After interest and amortization, the total you’ll pay if you bought at 5% today would be a whopping $183,561 less expensive than if you saved $168,306 for the same home 5 years from now.
WHAT DID WE LEARN?
Everyone tells you to save, and it’s good advice if it meant you’d be close to 20% today. If you did, these numbers would look completely different.
20% goes a lot farther the sooner you have it (duh!). If you don’t, make sure you’ve done the math, because saving isn’t always the best choice. The fact is, the value of homes is increasing faster than the interest rate, the CMHC fees and the amount of money people can save combined. So getting as much into a down payment as soon as possible is probably your best course of action.
Otherwise, you’re betting on the chance that interest rates decrease over time, that home values decrease over time, or you’re making so much more money over time that these factors won’t make a difference.
With all that said, we can appreciate these numbers and details can be quite intimidating, and the process of buying a home can seem daunting, but like all good things, we must sometimes simply dive in, immerse ourselves in it, and learn as we go.
You won’t be alone of course. There are countless resources online and in the form of family and friends who have bought homes themselves and we are more than happy to help you really understand these details in order to make an informed leap. Also, working with a realtor that also invests in real estate, can create a mentor-mentee relationship for the long-term outside of simply completing a transaction.
Written by: Sarah Miskelly – Lead Sales Representative
Thinking of getting into the market and unsure if you should buy now or wait and save? Connect with us to create a personalized roadmap to get you on the path to home ownership.