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Young couple sitting in front of a new house. (Photos.com)
Young couple sitting in front of a new house. (Photos.com)

Decoding the mortgage market

Canadians can still buy a house without saving their pennies Add to ...

It would seem that regulators want to dissuade Canadians from buying homes with nothing down. Yet despite all of the recent changes, buyers can still get into the real estate market with little cash on hand.

Ottawa did away with Canada Mortgage and Housing Corp .-insured 100 per cent financing back in 2008. Home buyers with few savings searching for an alternative were left with cash-back down payment mortgages. (That’s where a lender gives you your 5 per cent required down payment, in exchange for a higher rate.) But those didn’t last long because in 2012, regulators barred banks from offering cash back for down payments.

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Purchasing a home without your own down payment is often risky. One exception is when a borrower is well-qualified (apart from the down payment), has enough potential resources to withstand a loss of income and falling home prices, and is better off owning than renting. But exceptions are just that, and not the rule.

Young people use alternative down payment sources more often than most. Why? The main reason is a lack of savings. At a time when the average national home price has jumped to $356,687, the Canadian Association of Accredited Mortgage Professionals finds that more than one in four renters have less than $5,000 saved for a down payment. Yet, many of these folks are dead set on owning a home, so they end up using one of the down payment methods listed below.

Borrowing from other credit sources
When buying a home, you generally need at least 5 per cent of the purchase price as a down payment. Ottawa prohibits you from borrowing that 5 per cent from your mortgage lender if that lender is a bank or federal trust company.

Meanwhile, you’re free to borrow your down payment from a line of credit, personal loan or even a credit card. That’s right, if you’re creditworthy you can throw your down payment on a VISA at 20 per cent interest. Mind you, not all lenders allow this and the ones that do check that you can afford the extra debt payment.

One obvious problem with borrowing your down payment is the higher interest cost. Even if you use a line of credit, the interest rate on your down payment loan can be much higher than a regular mortgage, or have a riskier variable rate.

“Borrowing a down payment from less suitable sources is a potential issue,” acknowledges Gord McCallum, broker and president of First Foundation Inc. “Often times, with new mortgage regulations there can be unintended consequences that are worse than the problem they’re purported to solve, and this may be one of them.”

Getting a cash-back down payment mortgage
In many provinces, lenders that aren’t federally regulated (like credit unions) can still offer cash-back down payment mortgages. The few that actually do will give you 5 per cent cash to use for your down payment. You then need to cough up only your closing costs, which include legal and inspection fees, the land transfer tax and so on.

Not surprisingly, the interest rate on cash-back mortgages is well above a normal mortgage. But when you factor in the “free” cash, the overall borrowing cost isn’t that horrible. The main downside of a cash-back mortgage is that you have little equity cushion if home prices fall and you need to sell. And if you break the mortgage early, your lender can take back much or all of the cash it gave you.

Going forward, the days of cash-back down payment mortgages may be numbered. There is speculation that they’ll be eliminated in 2013–by either mortgage insurers, provincial regulators or both. For now, however, a handful of credit unions still offer them to people with strong credit, with Ontario-based Meridian Credit Union being the biggest such lender.

Using a gifted down payment
If you’re a young home buyer with a generous relative, you may be lucky enough to get your down payment as a gift. Most lenders will consider a gifted down payment if the donor is a parent, grandparent or sibling.

Unfortunately, while not an epidemic problem, it’s no secret that a small number of borrowers fraudulently claim their down payments as “gifts,” even though they fully intend to repay the money. That raises the risk level for lenders because the borrower’s debt obligations increase. Of course, both the borrower and giftor must attest in writing to gifted funds being non-repayable, but that is hard to police after closing.

RRSP Home Buyers Plan (HBP)
First-time buyers can borrow up to $25,000 from their RRSP as a down payment. But this is a very different kind of loan, for three reasons:

1. You’re borrowing from your own retirement savings, as opposed to a third party.

2. You don’t have to start repaying the loan until the second year after the year you make your withdrawal.

3. Even though Revenue Canada wants the funds paid back in 15 annual instalments, lenders don’t include those repayments in a borrower’s debt calculations. As a result, some people get approved for a mortgage only to find themselves caught in an annual cash crunch because they didn’t budget for their HBP payment.

The RRSP HBP comes with other perils. By draining your retirement savings, you risk losing years of tax-deferred investment gains. That’s a decision that some will later regret.

Moreover, any instalments that aren’t paid back on time are taxed as income in that year. And as many as one-quarter of HBP participants have missed or underpaid their instalments in the past.

Special lender and government programs
Various provinces and municipalities provide down payment assistance grants. These programs are typically for people with low or moderate income. Despite these borrowers being higher risk, in some cases, they’re permitted to buy a home with nothing down.

There are also specialized programs at individual lenders. For example, Canada’s biggest credit union, Vancity, currently finances an affordable condo project in Vancouver whereby it lends 90 per cent of the purchase price while the developer provides a 10 per cent second mortgage with no interest and no payments.

All of these down payment alternatives have one thing in common. They all come with some degree of added risk. It’s curious how Ottawa encourages people to have their own skin in the game, yet sanctions various substitutes to the traditional 5 per cent down payment.

If you do use one of these down payment alternatives, remember these two things: Buying a home without your own cash is not a decision to take lightly. And qualifying for a mortgage doesn’t mean can successfully carry one.

Robert McLister is the editor of CanadianMortgageTrends.com and a mortgage planner at VERICO intelliMortgage, a mortgage brokerage. You can also follow him on twitter at @CdnMortgageNews.

Follow on Twitter: @CdnMortgageNews

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