Becoming a homeowner is one of the most exciting adventures. The thrill of finding a home, the butterflies you get when you picture yourself living in it, the excitement of making an offer and the elation once it’s accepted.
The only thing that beats those feelings is the one when you step through your front door, take a deep breath and know: this is home.
We want to get you there and the first step is saving for a down payment.
Let's walk you through everything you need to know about your down payment, default mortgage insurance, stress testing your mortgage and the best strategies to save for your down payment.
How much should I borrow for my mortgage?
When a financial institution like a bank or a credit union pre-approves you for a mortgage, they look at your Gross Debt Service (GDS) and Total Debt Service (TDS) ratios.
Your GDS ratio captures the percentage of your income you need to pay your housing costs. To calculate your GDS, you add up your monthly housing-related costs, divide it by your gross monthly income and multiply that by 100.
Your TDS ratio, on the other hand, is the percentage of income you need to pay all of your debt.
If your GDS is below 35%, your financial institution will usually pre-approve you for a mortgage. There are exceptions where you could get approved with a GDS of 39% or even higher, but those cases are rare. For your TDS, the industry standard is 42% or less. What this means is that your lending institution is not just looking at how much house you're trying to buy compared to your income but how much debt you have as well.
If you’re wondering how much your monthly mortgage payment should be, you can do the reverse. Realizing that 35% is the limit you’ll generally get approved for, it's a good idea to aim to have a mortgage with a monthly payment under 35% of your monthly income.
Depending on your personal situation, you could afford more than 30% (you have no debt, lots of assets…) or less (you have consumer debt that you struggle to pay off, a lot of priorities competing over your finances...).
Our mortgage calculator will help you figure out how much house you can buy based on your personal situation.
How much should I save for a down payment on a house?
In Canada, the minimum down payment on a house is 5% if the purchase price is less than $500,000. If the purchase price is $1 million or more, the minimum down payment is 20%. If the purchase price is between $500,000 and $1 million, the minimum down payment will be 5% on the first $500,000 and 10% of any amount over $500,000.
As an example, if you buy a house for $650,000, your minimum down payment will be 5% of the first $500,000 ($25,000) plus 10% of the amount over $500,000.
$650,000 - $500,000 = $150,000 x 10% = $15,000
Your minimum down payment on a house you bought for $650,000 will be:
$25,000 + $15,000 = $40,000
That’s not all you have to take into account when you’re buying your home. If your down payment is less than 20%, you have to get mortgage default insurance, commonly known as CMHC insurance.
What is mortgage default insurance and why do I need it?
Mortgage default insurance is provided by CMHC or Sagen (formally Genworth) and is typically used when the down payment is between 5% (the minimum in Canada) and 19.99%. It’s a way to protect lenders in case the borrower defaults on their mortgage.
Mortgage default insurance essentially makes it possible for you to buy a home with a smaller down payment by providing a safety net to the financial institution lending to you.
The premium you'll pay for your mortgage default insurance is based on a percentage ranging from 2% to approximately 4% of the mortgage: the higher the down payment, the lower the premium. The premium is added to the mortgage and paid over the amortization period so you’re not required to pay the fee up front.
Here’s a breakdown of CMHC’s insurance rates:
(% of Home Price)
|5% - 9.99%||10% - 14.99%||15% - 19.99%||20% or more|
(% of mortgage)
What is the new stress test legislation and how does it affect my down payment?
The new stress test regulation is something that was introduced to curb the housing market while at the same time ensure people can afford their debt — especially mortgage payments — in the likely event interest rates go up.
In the past, you would qualify for your mortgage based on the actual rate you were getting on your contract, so let’s say 3.69% over a 35 year amortization. Now, with the stress test legislation, the maximum amortization is 25 years and you have to qualify either at the Bank of Canada qualifying rate or at your contract rate plus 2%, whichever is higher. The Bank of Canada qualifying rate is based on on the mode average of posted 5-year fixed rates from Canada's big banks. At the time of writing this article, the Bank of Canada qualifying rate is 4.79%.
In our example above, instead of qualifying at your contract rate of 3.69%, you have to qualify at 5.69% (your contract rate + 2%) because that's higher than Canada's benchmark rate of 4.79%.
This means that to stay within your lender’s guidelines, you might have to either put more money down or buy less house. While this may be frustrating, it is designed to protect you as a consumer to ensure that what you can afford to buy today you can afford to keep tomorrow.
If your down payment is less than 20%, the stress test won’t impact you as you need to qualify under CHMC/Sagen guidelines, which are already a 25-year amortization using the Bank of Canada benchmark rate currently at 4.79%.
How do I save for a down payment?
The first step to saving for your down payment is to figure out your time horizon. If you’re hoping to buy within three years or less, then you’ll probably want to use only term deposits. That’s because your deposit is guaranteed and you’re not going to lose that money.
If your goal is 3-5 years away, then you can look at saving mostly in terms but maybe have, say, 30% in a conservative fund.
BONUS TIP: As you’re saving for your down payment, put away as much as what your mortgage payment, strata, insurance, etc. will cost (including your current housing costs). That will help you save faster and adjust to the extra costs you might experience owning a home.
To end up with a $50,000 deposit over 5 years, you need to save about $785 a month with a return of 3%. If you can only count on a return of 2% (a generalized typical rate for term deposits), then you need to put $800 a month into your savings.
There are two options you can consider when it comes to saving for your down payment.
Save with your TFSA
The first is to save with your TFSA. Your TFSA is an incredible and flexible tool that allows you to save and grow your after-tax dollars. More than a savings account, it’s actually an account where you can hold investments, mutual funds, term deposits, etc.
Your TFSA contributions grow tax-free and — and this is the biggest benefit — your withdrawals are also tax-free.
This could be a good way to save if you are saving for your retirement on the side and that’s your priority; you don’t want anything to interfere with that.
Save with your RRSP
The second way is to save with your RRSP. The way your RRSP works is similar to the TFSA but the reverse: like the TFSA, you can hold all sorts of investments in it and your money grows tax free. The difference is your contributions are made with your before tax dollars (which is why you get a refund) and your withdrawals are taxed as income.
You might be wondering, why — if your withdrawals get taxed as income — is the RRSP a good way to save for a down payment? That’s because there are two exceptions where you won’t get taxed for withdrawing from it: the Lifelong Learning Plan and the Home Buyers Plan.
What is the Home Buyers Plan?
The Home Buyers Plan (HBP) is a federal program and how it works is pretty simple. You can withdraw up to $35,000 (that’s $70,000 per couple) from your RRSP, tax-free.
You’ll need to put that amount back into your RRSP within 15 years, at no interest. The only catch is if you don’t pay back the amount you took out, you’ll have to pay income tax on that withdrawal.
Here’s how to qualify for the Home Buyers’ Plan:
- you have to be a Canadian resident
- you can’t have owned a home in the last 4 years
- the withdrawal has to take place within 30 days of owning your home
- you have to have a written agreement to buy or build a home (e.g. an offer)
- you intend to use your home as your primary residence (not as rental income)
- you have to have the money saved in your RRSP for at least 90 days
Make your dreams reality
Owning a home is a huge milestone in a lot of people’s lives. In a lot of the cities in our province, affordability is becoming enough of an obstacle that a lot of younger people are wondering if they can achieve their dreams of owning a home without moving away.
The really good news is, there are a lot of ways to achieve that goal. You don’t have to figure out your plan alone. If owning a home within the next ten years is something you want to be able to do, then talk to a financial advisor. They’ll be able to look at your situation, provide the right resources and craft an action plan that will make that goal a reality.