Exploring the pros and cons of 20% down payment vs a smaller down payment

Buying a home is one of the most significant investments you'll make in your lifetime. One of the essential aspects of buying a home is making a down payment. There are pros and cons to a 20% down payment, and today we cover it all.

What is a down payment for your house?

A down payment is a percentage of the home's total value that you pay upfront when purchasing a home. The remaining balance is then financed through a mortgage.

For example, if you're purchasing a $500,000 home and making a 20% down payment, you would need to come up with $100,000 for it.

Why are down payments so important?

A down payment is essential when purchasing a home because it shows lenders that you're committed to the purchase and are financially responsible. When you make a down payment, you're putting your own money into the investment, which means you're less likely to default on your mortgage.

How much should you put down on the house?

The amount you should put down on your home will depend on your financial situation, your mortgage options, and your long-term financial goals.

While a 20% down payment is traditionally considered the gold standard, it's not always necessary or feasible. If you're a first-time homebuyer, you may qualify for a government-backed mortgage with a smaller down payment requirement. For instance, the Canada Mortgage and Housing Corporation (CMHC) offers mortgage insurance for borrowers with a down payment as low as 5% of the home's purchase price.

It's important to note that making a smaller down payment can mean you'll have higher monthly mortgage payments and more interest charges over the life of the mortgage. However, it may be a worthwhile tradeoff if it means you can afford to purchase a home sooner rather than later.

Pros of traditional 20% down payment

Here are a few quick and key pros of putting more down:

1. One of the most significant benefits of a 20% down payment is that it will give you access to better mortgage rates. A larger down payment demonstrates your commitment to the purchase and indicates you're a low-risk borrower.

2. Additionally, a 20% down payment reduces the interest you'll pay over the life of the mortgage.

3. Another benefit is that a larger down payment means you'll have lower monthly mortgage payments, leaving you with more money for other expenses.

4. The last one? You won’t have to worry about mortgage loan insurance. That’s an additional monthly fee tacked on mortgages with down payments of less than 20%.

Cons of traditional 20% down payment

Now, for the cons:

1. The most noteworthy drawback of a 20% down payment is that it can be challenging to save that amount of money. For many Canadians, coming up with $100,000 or more can be a significant financial burden.

2. Gathering a 20% down payment may also mean putting off other financial goals, such as retirement savings or paying off debt.

3. Another disadvantage is that tying up so much money in a down payment means you'll have less cash for emergencies or unexpected expenses.

Would a smaller down payment fit you best?

After reading through the above pros and cons, you’ll know whether a smaller down payment is the way to go.

If you land on the side of seeing more cons than pros for the traditional method, there’s no shame in putting a 5% or 10% down payment on your mortgage.

While you may have an additional mortgage loan insurance fee monthly, you can recoup some of your rainy-day savings.

In order for the best results when getting a mortgage sans a 20% down payment, be sure to boost your credit score so that you can still get a competitive rate and look like a strong candidate to lenders.

How to save for a down payment in Canada

Saving for a down payment requires discipline and a solid plan. If you're considering buying a home, it's important to start saving as soon as possible. Here are some tips to help you save for a down payment.

1. The first step in saving for a down payment is determining how much you need to save and by when. This will give you a clear target to work towards and help you stay motivated.

2. To save for a down payment, you need to know where your money is going. Start by tracking your expenses and identifying areas where you can cut back. This could include reducing your discretionary spending, cancelling subscriptions you no longer use, or eating out less often.

3. One of the easiest ways to save for a down payment is to set up automatic transfers from your checking account to a high-yield savings account. This way, a portion of your paycheck goes directly into savings without you having to think about it.

4. The Canadian government's Home Buyers' Plan (HBP) allows first-time homebuyers to withdraw up to $35,000 from their RRSPs tax-free to put towards a down payment. However, it's important to note that this money must be paid back to your RRSP over a 15-year period, or else it will be taxed as income.

5. There are several other government programs and incentives available to help Canadians save for a down payment. For example, the First-Time Home Buyer Incentive (FTHBI) offers shared equity mortgages to eligible first-time homebuyers, while the Home Adaptations for Seniors' Independence (HASI) program provides financial assistance for seniors to make home modifications that will allow them to age in place.

Final Thoughts

Buying a home is a major financial decision that requires careful consideration of your personal financial situation and goals. While a 20% down payment is considered the ideal benchmark, it may not be feasible or necessary for everyone. The amount you put down on your home will depend on your individual circumstances, such as your income, debt, credit score, and savings.

For some homebuyers, putting down less than 20% may be a viable option, as it can free up funds for other priorities or investments. However, this also means that you may have to pay private mortgage insurance (PMI) or a higher interest rate, which can increase your overall borrowing costs.

Ultimately, deciding how much to put down on your home should be based on carefully assessing your financial situation and long-term goals. Working with a trusted financial advisor, like nesto's very own mortgage experts, can help you weigh the pros and cons of different options and make an informed decision that aligns with your needs and priorities. nesto provides a transparent, unbiased mortgage experience from start to finish.