Rounding it up
Down payments are a good gauge as to whether you can afford a home or not.
It’s possible to get a zero down payment mortgage in Canada, but it involves borrowing the down payment, which can be financially dangerous.
That’s because by opting for a zero down payment mortgage, you’ll have no home equity cushion.
Plus, you’ll be subject to high mortgage insurance payments on a far larger debt.
One of the largest cheques you’re ever likely to write is the down payment for your mortgage. Down payments for most mortgages range from 5 to 20% of the purchase price — a significant chunk of change if your home comes in around the average sale price of $716,000. Have you ever wondered why you need to put money down in the first place? After all, you’re going to be in your home for a while and you plan on paying the mortgage. There’s got to be a way to get a mortgage without shelling out all that cash right?
Well, kind of. Zero down payment mortgages are technically illegal—Canadian parliament outlawed them in 2008. However, there are still ways you can have something similar to a zero down payment mortgage. But before you jump into this option, we’d recommend you ask yourself if it’s worth it. Let’s take a look at how you can get a mortgage without putting any money down, but we’ll also look at why it may not be the best strategy for you.
What is a down payment?
A down payment is the cash required by your mortgage lender when you purchase a home. It is a percentage of your home’s purchase price, ranging from between 5 and 20% in Canada. Your lender will use the down payment to calculate the loan-to-value (LTV) ratio of your mortgage. The LTV shows how much you’ll owe on your home after your purchase. For example, if you purchase your home for $500,000 and have a $100,000 down payment (20 percent), you will owe $400,000. This is expressed as a percentage, so $400,000 / $500,000 = 80% LTV.
Studies have shown that LTV and credit risk are closely linked. This means that the lower LTV you have, the better off you are to be as a borrower. Thus, down payment is a critical tool, along with your debt-to-income ratio (how much you already owe versus what you make), that lenders use to determine whether they will extend you credit.
Though less of a robust relationship, a down payment is also a good indicator as to whether you can afford to pay for and maintain a house. If you are straining to come up with 5% of the purchase price for a home, it may be a sign that the home is too expensive for you. Remember, your mortgage payments will be generally equal amounts for the life of your mortgage. The larger your initial mortgage is, the more difficult it can be to make those payments.
But zero down payment is still an option, right?
Yes and no. Prior to 2008, lenders could offer a zero down payment mortgage to borrowers. The financial crisis and the focus on stiffer regulations, specifically on mortgages, caused policymakers to require borrowers to submit a down payment with their mortgage purchase. There is, however, still a way that you can have a zero down payment mortgage, and that’s by borrowing the down payment in addition to the mortgage itself. This process, called a flex down, can often be initiated with your mortgage lender and come as a separate payment from your mortgage.
There could be some reasons why you may want to go down this road—perhaps you’re buying a second home or had to spend your down payment savings to settle an emergency. It is, however, a risky choice that can put you and your family in a very precarious financial situation.
Drawbacks of zero down payment mortgages
First, no down payment leaves you with a large amount of debt with no home equity cushion. Home equity is the difference between the amount you’ve paid and/or what your home is worth and the amount you still have to pay. For example, let's say that you took out a $500,000 mortgage, placed a down payment of $100,000, and have made $100,000 worth of payments. You have $200,000 worth of home equity. If you were to sell your home for $500,000 tomorrow, you’d be getting $200,000 in cash. With no down payment, you don’t have a foundation of equity on which to start.
Second, because you did not put down 20% as a down payment, you’ll be subject to mortgage insurance payments, which can be much higher if you have no down payment at all. These can range anywhere from 0.6 - 4.5% of your mortgage and you’ll have to pay that percentage, in addition to payments on principal and interest, until you’ve paid 20% of your mortgage. Mortgage insurance isn’t something that you necessarily want to pay; it’s something you’ll need to pay as it’s imposed or required of you by the lender to cover their loss if you default on the loan. It’s also often necessary in order purchase a home, especially since it’s not always possible to gather a 20% down payment.
Finally, in the long term, you’re paying interest on a far larger debt than you would be if you had put money down. Remember, that interest is a percentage of the principal you still have to pay. If you’re putting down no money, your principal is larger, thus your interest payments are larger. Consider this: If you buy a $500,000 home with 20% down ($100,000), at a 3% interest rate with a 30-year mortgage, you’ll pay approximately $758,000 over the life of the loan. If, however, you take the same loan but put nothing down, the same mortgage will cost you just over $900,000, before mortgage insurance. This calculation makes a number of assumptions, but the result is the same—if you don’t put down any money, you’re paying a heck of a lot more than you normally would.
But what if I can’t afford 20%?
Luckily, there are a number of ways you can get into the home of your dreams without a 20% down payment while avoiding the negative consequences of going with the zero down payment option.
You can borrow up to $35,000 from your Registered Retirement Savings Plan (RRSP) account and pay it back over the next 15 years. The funds must go to the purchase or construction of a home. Additionally, you can take advantage of the first-time home buyer tax credit. The government of Canada offers first-time home buyers up to 5% of the purchase for an existing home and up to 10% for the construction of a new home. It must be repaid over the next 25 years or when you sell your home. You can learn more about whether you’re eligible for the initiative by visiting Canada’s Home Buyer website.
These funds can help you afford the private mortgage insurance your lender will add if you put down less than 20%. This insurance covers your lender in the event of you defaulting on your mortgage and you’re required to carry it until you reach 20% of your principal balance in payments. It's possible to get a mortgage with no down payment requirement but there are very few good reasons to do so. If you are unable to afford a down payment of any kind, even with the assistance offered by the government, it could be a sign that it’s not the right time to purchase a home. If you can get some capital together for a down payment, but it falls under 20%, there are a number of options that can help make getting into your home a bit easier, including support from the government. At this rate, insurance is a requirement but could be a price well worth paying if you can afford and move into your new home.
Dan is a runner and writer living in the Washington, D.C. area, where he currently works for a financial services trade association as the Communications Director.