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  (Richard Buchan/The Canadian Press)

 

(Richard Buchan/The Canadian Press)

Decoding the mortgage market

Save up for a down payment? The young adult's struggle Add to ...

If you asked 100 recent home buyers if they were satisfied with the size of their down payment, as many as 60 of them would say no. That’s what TD Canada Trust found in a recent survey of first time home buyers.

This finding is hardly surprising: A bigger down payment means less interest paid, easier refinancing, lower mortgage insurance fees, and a bigger equity buffer if home prices slide.

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The challenge, in a world of record-high debt ratios, skimpy investment returns and towering home prices, is saving a sizable deposit. Frustrated by the long, slow process, some new buyers would rather throw in the savings towel and get the keys to their new home faster. In fact, 55 per cent of first-timers surveyed by TD said they would buy sooner if they had a chance to do it all over again.

The problem is it takes time to save up a down payment.

The minimum price of admission to home ownership is currently set at 5 per cent. (This ignores 100 per cent financing – also known as cash-back down payment mortgages – because they’re usually ill-advised and they may not be around for long.)

People who responded to the TD poll estimated that it takes an average of “two years or less” to save a 5 per cent down payment and “one to four years” to save a 10 to 20 per cent down payment.

If that strikes you as optimistic, you’re not alone.

For today’s highly leveraged consumer, saving a down payment isn’t as easy as it was in the early 1980s when personal savings rates exceeded 20 per cent.

The national average purchase price for a first-time buyer has soared to roughly $295,000, according to a May estimate from mortgage insurer Genworth Financial Canada. That means the average first-time buyer would need to save more than $16,000 to cover the minimum 5 per cent down payment and closing costs.

For a 10 per cent down payment and closing costs, he or she would have to save at least $31,000.

How long does it take young people to scrape together that kind of money?

Doug Porter, deputy chief economist at BMO Capital Markets, says the rate of savings has been trending near 4 per cent and the median family income is just shy of $70,000. “The median family would, by this measure, be saving about $2,800 annually,” he adds.

The annual cash savings of first-time buyers – who are on average 34 years old, according to CMHC – would be somewhat less than the median family. And understandably, socking away a good chunk would be even harder for a single person.

“I would suspect that on a median basis, just to get in the housing market (with 5 per cent down), would take about four to five years of saving. Cobbling together a down payment is a big challenge for first-time buyers,” Mr. Porter says.

“Frankly, I think that’s one of the reasons why the government hasn’t raised the minimum down payment. It’s almost a nuclear option.”

None of this is meant to discourage saving for a down payment. Saving longer gives you a bigger cushion if home prices tumble and you need to sell. The last thing anyone wants is to owe more than their home is worth.

It also gets you a better entry price if the market sells off before you buy. According to surveys of housing forecasters, a price correction in the next few years is the most likely scenario.

In terms of mortgage costs, buying with 10 per cent equity, versus the 5 per cent minimum, can save the typical entry-level buyer up to $80 a month in payments, plus almost $2,400 in default insurance premiums. These savings, however, can easily be overshadowed if home values march higher. Buying today also lets you lock in abnormally low fixed mortgage rates for up to a decade.

But as a first-time buyer, you’ve got other things to consider, including:

• Your rental costs. (Are they higher or lower than your potential ownership costs?)

• Alternative uses for your down payment money. (Can you get a better return by investing down payment funds elsewhere?)

• The size of your emergency fund. (Home ownership comes with a laundry list of unexpected expenses.)

• Your economic stability and future earning power.

There are several ways to piece together a bigger down payment. You can:

• Cut your spending. “If you are saving for a house you might be a little more aggressive than the average saver,” Mr. Porter says.

• Tap into the bank of mom and dad. Gifts from parents get a lot of young people started as home owners.

• Borrow from your RRSP under the Home Buyers’ Plan (HBP).

• Apply tax refunds and bonuses.

• Get rid of one car in a two-car household.

• Postpone a vacation for 18 months or more.

• Use municipal first-time home buyer grants when applicable (like this one in Winnipeg, this one in Surrey, BC, or this one in Saskatoon).

People need to pay some sort of shelter cost, either in the form of a mortgage or rent, says TD Canada Trust’s director of mortgage advice, Farhaneh Haque. “As long as people have gone through the exercise of understanding what money they have coming in, asking is my job stable, will my income increase or decrease, looking at their financial strength…and building in a cushion for potential interest rate increases,” then a decision to buy a home sooner often makes sense.

TD’s advice for first-timers is to aim for 20 per cent down. But simple math shows that a 20 per cent down payment could take some people over a decade to accumulate.

The reality is, waiting that long is not in the game plan for most young people.

Robert McLister is the editor of CanadianMortgageTrends.com and a mortgage planner at Mortgage Architects. You can also follow him on twitter at @CdnMortgageNews.

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