Buying real estate: 8 advantages of making a 20% down payment
When you consider the total price of purchasing a property, a 20% down payment might seem daunting. But as a financial strategy, it has some real advantages. Here are 8 reasons why making a down payment of 20% or more could be a smart move for you.
1. Avoiding the need for mortgage insurance
If your down payment is under 20%, mortgage insurance is mandatory. Mortgage insurance protects the lender—and not you, the borrower—in the event that you default on a payment. The mortgage insurance premium, which ranges from 0.60% to 4.50%, is also subject to provincial sales tax (QST). Obviously, the cost of this insurance rises very quickly depending on the size of your loan and can easily reach thousands of dollars. Investing a 20% down payment allows you to avoid paying these additional costs.
2. Paying less fees and interest on the loan amount
Opting for a larger down payment reduces the amount of your mortgage loan. So, if you were paying 4% interest over 25 years, a down payment of at least 20% would reduce the total fees applicable to your mortgage loan. For example: if you bought a property worth $400,000 with a 5% down payment, the total cost of your home, including the mortgage, financial institution’s interest rate and insurance premium, would be $643,649 ($243,649 in fees). With a 10% down payment, it would drop to $625,712 ($225,712 in fees); and with a 20% down payment, it would drop to $548,979 ($184,979 in fees). The difference speaks for itself.
3. Reducing your overall debt
The larger your down payment, the smaller your debt. An important principle to follow is that you should never exceed a debt service ratio of 32% of your pre-tax gross income for all expenses related to purchasing a home. According to the Central Bank of Canada, the total debt of Canadian households has increased by 4% relative to household income since the start of the pandemic. With the current rise in the cost of living, this puts homeowners at risk in the event that they exceed their financial capability (or temporarily lose their job).
4. Reducing the risk associated with rising interest rates
Property prices rose at historic levels during the pandemic. Many households purchased homes at high prices, relying on the low mortgage rates available at the time of purchase. With the Bank of Canada recently increasing its benchmark interest rate from 1% to 1.5% and the increases expected in the coming years, investing in a down payment of 20% or more to reduce your total mortgage is definitely a strategy to consider.
5. Access to amortization periods of more than 25 years
Thinking of taking out a mortgage with an amortization period of more than 25 years? Only homeowners with a minimum down payment of at least 20% have access to longer amortization periods with financial institutions.
6. Acquiring an undivided property
Unlike divided ownership (e.g., most condominium projects), undivided ownership does not involve a syndicate. Undivided ownership means you are purchasing a percentage of an entire property belonging to several owners (through an indivision agreement), with private portions. With this type of real estate, you are required to put 20% of the value of the residence as a down payment; otherwise, you cannot purchase it.
7. Avoiding mortgage rules
In 2016 and 2021, the federal government introduced a series of measures designed to reduce the number of buyers putting themselves in overly risky situations. The strategy is to qualify applicants by calculating their capacity to repay a loan if the interest rate were to rise to 5.25%, for instance when their mortgage is renewed five years later. This calculation is known as [V3]the stress test. According to Multi-Prêts Mortgages, these rules do not apply to mortgages exceeding 20%.
8. Minimum amount for a home over $1M
Interested in purchasing a property worth more than $1 million? The minimum down payment is—you guessed it!—20%.
To conclude: making a 20% down payment is clearly an excellent financial strategy that helps you to save for the long term, and also to open the doors to your dream property with security and peace of mind.
Happy investing!
