Why you DO NOT need 20% down to buy your first home

There are so many clients that I speak with, expressing that they are working towards saving 20% for a down payment on a home.

I’m going to go over why I didn’t wait to have 20% down and why you don’t need to either.

Saving 20% of a home’s purchase price is obviously a long and challenging journey for many. I see more people staying out of the real estate market, because they are under the impression that it is best to put 20% down on a home, so that they avoid paying the CMHC premium. But the question is, is it worth waiting longer to by just in order to put 20% down?

Let me jump into this topic by asking you:

  • How much money do you currently have saved?
  • How long did it take you to save that amount?

I’m guessing that since you’re reading this blog, you don’t have 20% down yet, but you do have a small amount of money saved up. Once you’ve answered the two questions above to yourself, then we can move on to the fun stuff… the numbers!

Disclaimer: I am not a mortgage broker, only a Licensed Realtor. These figures are approximations only. Please seek professional advice from your bank or mortgage broker. These are my opinions only and are not to be relied upon.

Condo purchase scenario

Let’s say you are wanting to buy a $500,000 condo.

You currently have 10% down, so you have $50,000.

You are still waiting to buy because your parents, friends, or possibly mortgage broker told you that you should wait until you have 20% down in order to avoid the CMHC premium (Canada Mortgage Housing Corporation).

If you need 20% down, you would currently need $100,000. But you don’t have that yet so that means you will need to save an additional $50,000. Let’s assume that in order to save that $50,000, it will take you another 5 years because you will save $10,000 per year.

CMHC fee

If we move ahead and say that instead of waiting 5 years to have 20% down, you decide to go ahead and buy a home TODAY. If you do, the CMHC fee will approximately be $13,950. That amount, will get rolled into your mortgage.

How much does the fee REALLY work out to?

If you were to mortgage your house and weren’t charged the CMHC fee, your annual mortgage payments would be approximately $25,833.

But of course, that isn’t the way it works. Because if you put less than 20% down then you are in fact charged a CMHC fee. As you can see from the next diagram, your annual mortgage payments would be approximately $26,634, with the CMHC fee included.

That is only an increased difference of $801 per year, by having the extra CHMC payments rolled into your mortgage, which isn’t a big financial hit when you think about it!

Seriously, why are you putting off buying if the added cost works out to being about $801 more per year? Instead, you would rather continue to work and save to come up with the extra $50,000 down payment so that you can avoid paying this fee? Here’s how that scenario looks.

Waiting, working, and saving

Let’s look at the historical 5 year trend in Metro Vancouver for average condo prices. The reason why we’re looking at the past 5 years is two fold: 1) we generally forecast future amounts by looking at historical figures to help predict future outcomes 2) We can see how much the real estate market has grown over the past 5 years to see the growth rate over the 5 year average.

As you will see from the diagram below, the average growth rate in Metro Vancouver (which is all of the surrounding cities of Vancouver) was 12.8% per year from 2015 to 2019. The average condo was priced at about $400,000 in 2015 and as of June 2019, it was priced at $655,000.

To clarify, 12.8% per year is a massive growth rate, as the average inflation rate is about 3%. So we don’t want to assume that the future will grow at that same rate.

The diagram below shows what a $500,000 condo today, in 2019, could be worth in the next 5 years. You can try this out on your own and use various growth rates.

I used the high growth rate to forecast the next 5 years, along with a lower growth rate of 6% for this example.

If you were saving to have 20% as a down payment for a condo that is valued at $500,000 today, you will actually need to continue saving and have $133,823 in 5 years because the average value of those homes will have increased.

I see many people playing this down payment savings game for many many years because they can’t manage to save up the 20%, as prices continue to increase. You don’t want to be a part of that game!

Lower interest rate with less than 20% down

One last important point to add that many people are unaware of is that you also get a better interest rate when you put less than 20% down!

This may seem counter-intuitive, but as we went over, when you put less than 20% down, you are insured with CMHC, so you are less risk to your Mortgage Lender!

The Lender knows that if you default, they are still getting their money, because you are insured. Contact me and I’ll set you up with a mortgage broker if you want to learn more about this.

Remember, the goal here, is that I want you to just get into the market. That’s key and that’s the primary goal. You’ll see that once you’re in the market, it’s a lot easier to upsize and also, to make a lot of money in the appreciation of the home over time. Said differently, get yourself into a cozy and less expensive condo now and then move your way up!

Contact me if you want to start your search for your first home in the Lower Mainland, let’s get started.