Coming up with a sufficient down payment is often a challenge, particularly for first time buyers. Knowing what sources are acceptable, how much you will need and the documentation required will make your mortgage approval a much smoother process.
How Much Down Payment Do I Need?
The minimum down payment requirements depend upon the type of property being purchased, whether it is owner occupied or a rental, and also on the documents a borrower has to support their income. In most cases, if a borrower has a down payment of less than 20% the mortgage must also be insured through CMHC, Genworth or Canada Guaranty and will be subject to the requirements of both the lender and the insurer.
1. Owner-Occupied properties (1-2 units: 5%; 3-4 units: 10%): As a general rule a minimum of 5% of the purchase price is required to purchase an owner-occupied property containing one or two units. If the property has 3 or 4 units a minimum of 10% is required. In each case at least one of the units must be occupied by the borrower.
2. Self-Employed Borrowers with Non-Verifiable Income (10%): Self–employed borrowers who can provide documentation to support their incomes can proceed under the standard down payment rules. However, some self-employed borrowers do not have the required documentation, or the documentation does not reflect their true income. Qualified borrowers in such a situation can proceed under what is known as a “stated income” program with less stringent documentation requirements, but higher minimum credit requirements. For borrowers who qualify under these programs a minimum down payment of 10% is required. 5% must be from their own resources. The rest may be a gift from an immediate family member. Insurance fees are higher than in a standard provable income situation and may be charged even if the borrower has a down payment of 20% or more. Purchases under these programs are restricted to a maximum of 2 units, one of which must be owner occupied.
3. Rental Properties (1-4 Units: 20%): If the property is a rental property of one to four units, with none of the units being occupied by the borrower, a down payment of 20% will be required. As with the stated income programs, insurance fees may be charged even with a 20% down payment. The down payment is often required to be from the borrower’s own resources, but may also be a gift from an immediate family member or borrowed against proven assets, depending on the insurer. Properties with more than 5 units are usually treated as a commercial mortgage and different underwriting guidelines.
What Sources are Acceptable?
1. Borrower’s Own Funds: When the down payment is coming from the borrower’s own savings or investments, the borrower will be required to provide statements showing that the funds have been in the borrower’s possession for at least 90 days. Any large deposits within that 90 day period will require an explanation and perhaps further documentation (an inheritance or bonus from work, for example). Funds that have been transferred from another country may be subject to special scrutiny and require additional documentation. This type of down payment is acceptable for all types of properties and incomes.
2. RRSPs: If RRSPs are being used for a down payment there are two options: withdraw the funds and prepare for a large tax hit (not recommended) or use the Home Buyer’s Plan (HBP). The HBP allows qualifying first time buyers to withdraw up to $25,000 from their RRSPs to use as a down payment. There are a number of requirements and conditions that must be met in order to use this program and the funds withdrawn must be paid back into the RRSP within 15 years. The HBP can be used for a down payment only for owner-occupied properties. For further details please click here.
3. Gifts: Gifts from immediate family members are generally as acceptable as down payments from the borrower’s own resources. The borrower and the family member providing the gift must provide a letter or document stating that it is a gift and that it is not repayable. Prior to closing, the borrower will have to provide bank statements showing the deposit of the gift into their account. In some cases the lender may also ask for a 90 day history of the funds from the family member giving the gift.
A gift from someone other than an immediate family member may also qualify as a down payment but the mortgage may be subject to a higher insurance premium and a higher credit score may be required. For self-employed borrowers under the stated income program, the gift can be from an immediate family member only.
4. Sale of an Existing Property: If the down payment is coming for the proceeds of the sale of another property, the lender will need to see a bank statement showing that those funds have been deposited into the borrower’s account along with proof that the funds came from the sale.
If the sale will occur after the purchase of the new property, bridge financing will have to be arranged to provide the down payment until the funds from the sale are released. In such a case the lender will require a copy of the agreement of purchase and sale for the property being sold before the mortgage for the purchase is advanced. The lender will also require confirmation that there is sufficient equity in the property to provide the down payment following the sale. A statement from the solicitor is usually sufficient, setting out the proceeds that will be payable to the borrower after any mortgages, real estate commissions and other fees and expenses are paid.
5. Borrowed Funds: Funds for a down payment may be borrowed from another source, such as a line of credit. However, the monthly payments on the borrowed funds will be included in calculating the borrower’s overall debt load and may lower the amount of mortgage that the borrower can qualify for. Further, if the source of the borrowed funds is unsecured (such as a personal line of credit as opposed to a home equity line of credit) additional insurance premiums and credit requirements may apply. For more information on how other debts can affect a mortgage approval please click here.
6. Cash-Back: Some lenders still offer cash-back of up to 5% of the purchase price, which can be used as a down payment. Rates are higher on these mortgages, however. Since lenders can only insure a mortgage for up to 95% of the purchase price, the cash-back portion is really a separate loan outside the mortgage. A higher rate on the mortgage is required in order for the lender to recoup the cost of the cash-back portion over the course of the term. Cash back mortgage are only available for owner-occupied properties up to 2 units and are not available under the stated income programs for self-employed borrowers. Insurance premium are also higher and credit requirements are stricter.
Although not exhaustive, there are very few situations where the down payment won’t fit into one or more of the above situations. Borrowers will also have to ensure that they meet the credit and income requirements for any purchase that they are considering.
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John Freeland Smith