What Are Your Down Payment Options?

The Bank of Canada went to great lengths to make purchasing a home without a down payment difficult. As it turns out, all those mortgage rule changes, the last in July of 2012, did slow purchases down somewhat, but some homebuyers are finding ways to get around those rules.

One of the things Ottawa eliminated was the Canada Mortgage and Housing Corporation insuring a property with a mortgage for 100 percent of its value. That was back in 2008. Potential home buyers without sufficient down payments ended up using a cash-back down type of mortgage. A lender will also back the required five percent down at a higher interest rate. That continued until 2012, when the latest change in mortgage rules banned the practice.

No Down Payment Purchases

It’s usually risky to buy a home with nothing down. It’s different if the buyer is well qualified with sufficient assets to weather a down period, but still not the best of ideas. Most people without a down may find things difficult if they perhaps loose their income or the value of their property decreases significantly. In those cases renting is a better option.

Alternative down payment options are out there, most often used by younger people. This part of the population is less likely to have a sufficient down but still insists on owning a home. The Canadian Association of Accredited Mortgage Professionals noted in a recent survey that roughly 25 percent of those renting had less than $5,000 put away towards a down payment. That is not nearly enough to cover what’s needed when the average price of a home in Canada is $356,687.

Alternative Credit Sources

Purchasing a home usually means having five percent of the agreed price as a down. The mortgage rules do not allow you to borrow that five percent from the same mortgage lender if you are using a traditional bank or a company that operates as a federal trust.

You may borrow that money from your line of credit, your credit card or even take out a personal loan. That can mean some hefty interest, roughly 20 percent on that credit card in some cases. Not all lenders will go along with this, and those that do will do an additional credit check to make sure you can afford the additional payments.

The problem with borrowing a down is that you face higher interest rates than on a traditional mortgage. Lines of credit often have variable rates, thus adding a bit of financial uncertainty to your monthly debt load.

These practices are not what the creators of the new mortgage rules intended. Borrowing your down can cause potential problems, and in fact can be an indicator that you are not financially ready to purchase a home.

The Cash-Back Down Payment Mortgage

It is still possible to get such a mortgage, if you go to a financial institution that is not federally regulated. Credit unions are one of those sources. Those willing to offer cash-back mortgages offer five percent of the purchase price for that down payment. Then it’s up to you to fund the closing costs which include the inspection and legal fees, transfer tax and other expenses.

The interest rates on these loans are considerably higher, but then the upfront cash does ease the bite somewhat. But, using this type of loan rather than your own cash means that if home values decrease your have little equity to fall back on if needed. Also, if you pay off or otherwise break the mortgage before the term, the lender can take the all or part of the “free’ cash back.

These types of mortgages may be a thing of the past by the end of 2013. Other regulators, such as provincial entities or mortgage insurers may eliminate them. Until then a few credit unions still provide these loans to buyers with a strong credit history.

Down Payment Gifts

Sometimes young buyers are lucky enough to get their down payment as a gift from a relative. Most lenders are willing to consider such a down if the person doing the gifting is closely related. That means a parent, grandparent, brother or sister.  That distant cousin on your family tree won’t work.

There are a number of people who claim these funds as gifts while in fact they are in-family loans. It’s hard for lenders to judge whether this type of gift is legit, so many will ask the gift giver and the borrower to sign documents stating the money does not need to be repaid. But, after the deal closes, it is hard for the lenders to follow up. The risk to the lender is that you will have a higher debt load, which may get you into financial trouble over time.

Using the RRSP Home Buyers Plan

If you are a first time homebuyer, you are allowed to borrow from your RRSP for a down payment. The maximum amount is $25,000, which covers the down nicely on most starter homes. But these HBP loans are somewhat different.

First, you are getting the funds from your own retirement account. Second, the repayment doesn’t start until two years after the year you take out the loan. And third, Revenue Canada wants those payments made in 15 annual installments. But, lenders do not include these payments when qualifying a client. In some cases buyers find they are scrambling for the additional cash each year to meet that HSP obligation. Missed payments are taxed as income. Roughly 25 percent of those that took out the HSP have missed those payments.

Another thing is that as long as your RRSP money is tied up in your down payment, your retirement savings is not earning on the investment market. That may put a crimp in your retirement plans later on.

Government and Other Special Lender Programs

Some provinces as well as individual municipalities offer some type of assistance grants for down payments. Usually these are targeted towards those with low to moderate incomes. Even though some individuals are in a higher risk category, this makes it possible to buy property without a down.

Individual lenders sometimes offer their own programs. Vancity, one of the nation’s largest credit unions, offers financing on affordable condos in Vancouver. It puts up 90 percent of the purchase price while the developer comes up with the additional ten percent in a second mortgage that has no interest or payments.

Risk is the underlying word in all of the above alternate down payment plans. Added risk, actually. If you are in the market for a home, consider this: Buying a home without a down that comes out of your pocket may not be in your best interest. Also, just because you qualify for a mortgage doesn’t mean you’ll have an easy time with the payments. Borrowing the down usually makes meeting those payments that much more difficult.