This post is mainly aimed at explaining the cost associated with the size of the down payment you use to purchase a home. The ideal amount is 20% or more because then you can avoid default insurance premiums. You can buy a home with no money down, which is now referred to as a cash back mortgage, but it can be a risky way to get into home ownership, although it is sometimes the only choice. There is not longer 0% down payment in Canada, this was removed to help prevent a collapse in the Canadian mortgage market, such that happened in the States. You can still buy a home without a down payment it is just referred to as a cashback mortgage.
For the purpose of this post let's just look at a $200,000 purchase price for a owner occupied home, at 4% interest on a five year fixed with a 25 year amortization. If your down payment is 20% ($40,000) you will not have to pay any default insurance fees. There is a sliding scale for how much the default premium will be with less than 20% down. You can view this chart from CMHC "here". Not very many people have a 20% down payment when they are starting out so most do end up using mortgage default insurance.
Now for a 200k purchase with 5% ($10,000) down you are looking at an insurance premium of 2.75% or $5,225. This amount is added to your mortgage balance and works out to be $27.48 monthly integrated into your mortgage payment. You also have to pay $418 PST on this amount on closing as part of your closing costs. The total monthy mortgage payment would be $1,026.92.
Let's say you do opt for the 5% cash back. Your insurance premium will increase to 2.90% ($5,510) as well your interest rate will generally increase to the bank posted rate which is currently 5.69%. This higher interest rate is put into place so the bank can recoup the 5% cash back within 5 years. This increase in rate over 5 years works out to $188.17 monthly or $11290.20. Now remember you are paying back the bank your 5% ($10,000) down payment so it is actually costing you $1,290.20 ($21.50 monthly) to borrow the down payment. After 5 years you are free to switch lenders and return to normal interest rates.
One thing you want to keep in mind when considering this type of mortgage is your ability to break the mortgage. When you sign mortgage papers at a lawyers office you are entering into a contract. If you break this contract there is penalties either 3 months interest or interest rate diferential, whichever is greater. So lets say after two years you wish to sell the home and move to the islands. (P.S. I just added the link to be cute, they aren't paying me.)
Pretend current rates are around 4.5% you are still at 5.69%. The interest differential is basically the amount of money the bank is losing based on your interest rate compared to current interest rates. This is 1.19%, so the bank will calculate how much this is and charge you based on the remaining 3 years, basically about $6,700. Plus you will have to pay back the remainder of the down payment still outstanding, around $6,000, a total of $12,700. The average home increase in value about 4% a year which will give you an additional $16,320 of value but with a 5% Realtor fee and lawyer costs this adds up to aproximatley $25,700 to sell your home. This does not leave you with much left over.
Lets look at the numbers:
-10,000 Borrowed down payment
+ 5,510 Insurance premium
$195,510 Mortgage balance
Two years later you decide to sell your home is now worth approximately $216,320. From this amount you need to subtract all costs to see where you stand.
$188,000 Aprox. current balance
+12,000 Realty fees and taxes
+1,000 Lawyer costs
+6,000 Remainder of down payment
$213,700 To sell
You may if your lucky end up with $2,500 in your pocket and this is assuming the market does increase in value.
If you decide to sell and move up to a bigger home your bank may allow your to do so and give you a blended rate if you have enough equity in your home or additial funds for a large enough down payment.
Often people will recieve gifts from parents to use as the 5% down to avoid the extra costs. Not everyone has this option. There is 1-4% cash back options if you have some money.
I am a fan of the 5% cashback mortgage as long as people are aware what they are getting into and accept the reality and understand the big picture. It is a good way to get into home ownership especially if you are starting a family and do not have the time to save.
Feel free to reply or ask questions.