This article, written by Rob Carrick, first appeared September 24th in The Globe and Mail.
This one’s for the housing true believers out there.
You’re the buyers who keep pushing house prices higher in cities such as Vancouver, Toronto and Hamilton. Incomes are edging higher in these cities, prices are surging. If you’re primed to buy anyway, then listen up. Stop trying to save a 20-per-cent down payment and get into the market now.
A popular and sensible bit of financial advice is that you should ideally wait to buy a house until you have a down payment of at least 20 per cent and thus are excused from buying mortgage default insurance. But if it takes a few years to save that much, you may find that soaring prices more than offset the savings on mortgage insurance.
This insurance got a little more expensive in some cases this summer, so it’s time for a fresh look at the case for avoiding the cost of buying it.
Background for housing rookies: If you have a down payment of less than 20 per cent, you have to pay a hefty premium to insure your lender in case you default on your payments. The amount is usually added to your mortgage principal, which means it’s out of sight and out of mind. But it still costs you.
With a down payment of less than 10 per cent (5 per cent is the minimum), the cost of mortgage insurance rose in June to 3.6 per cent of the purchase price from 3.15 per cent. Larger down payments short of 20 per cent were unaffected and range from 2.4 per cent down to 1.8 per cent. You’ll pay provincial sales tax on those amounts in Manitoba, Ontario and Quebec. More importantly, you’ll incur extra interest charges by adding these amounts to your mortgage balance.
Let’s use the average resale house price in Canada to illustrate how much mortgage insurance adds to your costs when buying a first home. The average price in August was $433,367 – a calculator from Canada Mortgage and Housing Corp., a supplier of mortgage insurance, shows that a 10-per-cent down payment would trigger a mortgage insurance premium of $9,361. With that amount added to the mortgage, monthly payments on a five-year fixed mortgage at 2.59 per cent would be $1,807 per month.
With a 20-per-cent down payment, monthly costs on this mortgage fall to $1,569. Total interest over the five-year term of the mortgage falls to $41,390 from $47,681, a difference of $6,291. But would it really be worth postponing your purchase by three years to put 20 per cent down? With the market rising at 5 per cent annually (less than recent increases in Vancouver, Toronto and Hamilton), the chart that goes with this column shows you’d actually end up paying more per month.
Mortgage rates also have to figure into your thinking on whether to buy now or wait and save more. If we assume 4 per cent average annual price increases over three years and a rise in mortgage rates of one percentage point, you’d have to pay substantially more than if you bought now and paid for mortgage insurance (see chart).
If you live in a city with a slow real estate market, it pays to wait and save more. If you waited three years to double your down payment to 20 per cent on the average-priced house and prices rose 2 per cent annually, you’d come out ahead by more than $140 per month.
A June study issued by the Canadian Association of Accredited Mortgage Professionals said the average house down payment for first-time buyers was $67,000. That represents a 21 per cent down payment on the average $318,000 spent by first-timers, and a 15.5-per-cent down payment on the overall average price of $433,367.
The CAAMP study found that 18 per cent of first-time buyers received gifts or loans from family. A thought for parents who want to help their kids get into the market: Try topping up their down payment to reach the 20 per cent threshold. Warning: Parents should avoid this type of financial help if they have to go into debt to provide it, or if it greases the way for their kids to buy a house they can’t properly afford to carry.
Down payments are one of the least strategized parts of home buying, and yet they can have a big impact on your total long-term cost of owning a house. The conventional wisdom about 20-per-cent down payments is right on the money, but not if you’re set on buying in a hot market. Either jump in now or resolve to wait and save indefinitely for sanity to return.
Buy a house now or wait to save more?
Let's assume you can afford to buy a house in today's market, but you're thinking of holding off to save more money so you can build a 20 per cent down payment and avoid paying the premium for mortgage default insurance. Will you save money by waiting and saving more, or might rising house prices and mortgage rates end up costing you more? Here are some examples using the August average resale house price.
|Scenarios||You buy now with a 10% down paymet||You wait three years to build a 20% down payment and prices rice 5% annually||You wait three years to build a 20% down payment and prices rise 4% a year while mortgage rates rise by one percentage point||You wait three years to build a 20% down payment and prices rise 2% annually while mortgage rates stay the same|
|Term interest cost||$47,681||$47,914||$64,985||$43,923|