When purchasing a home, the borrower is required to come up with a portion of the purchase price in addition to the mortgage, this referred to as the downpayment. There are multiple downpayment sources that are acceptable to most mortgage lenders, and this week I want to explore the most common ones. While you can still technically buy a home with zero downpayment funds on hand, given the process involved I’m not convinced it’s the best idea. If you’re main goal is to build equity in your new home as quickly as possible, the more funds you have invested into the purchase initially, the better.
The minimum downpayment required by most mortgage lenders is 5 percent of the purchase price, meaning they will not finance a first mortgage that is higher than 95 percent of the property purchase price. If you have less than a 20 percent downpayment, a high-ratio mortgage insurance premium will be charged, and it's often added to your total mortgage amount. The more downpayment funds you have, the lower the insurance premium. Keep reading for some brief details on eligible downpayment sources as well as what kind of documentation you can expect to be asked for as confirmation of those funds.
This describes any funds you have accumulated over time and would like to use towards your downpayment. These funds can be sitting in your bank account as savings, RRSPs or an investment account. Basically any account with your name on it where the funds have been accumulating over a period of time. You can expect to be asked to provide a 60 to 90-day transaction history of those funds, along with a paper trail for any unexplained and unusual large deposits made during that period. If the funds are coming from your RRSP, you may be asked to provide proof the funds have been withdrawn from your RRSP and deposited into your bank account. Be sure to fully research if you are eligible under the First Time Home Buyers’ Plan that allows for RRSP withdrawal without as many income tax ramifications.
Rent-to-Owns are also viewed as being a saved downpayment as long as the Rent-to-Own agreement clearly outlines a set monthly instalment portion is credited towards downpayment in addition to the market rent you have already paid. Be aware that some lenders may also require proof of the funds accumulating in a separate account. As not all lenders consider Rent-to-Owns as an eligible downpayment source, in this case, you may want to work with a mortgage professional with access to multiple lender options to ensure one can be found who will allow the downpayment to come from rent-to-own sources.
An immediate family member can gift you the downpayment funds to use towards your home purchase. Your lender will request confirmation of deposit of the gifted funds into your bank account and your family member will be asked to sign a gift letter stating the funds do not need to be repaid. In some cases, the lender may ask for confirmation the gift provider has the available funds on deposit in order to give to you. If you have any questions or concerns as to whether you can meet the gifted downpayment requirements, have a discussion with your mortgage professional sooner than later to determine if an exception can be made. For example, if your gifted funds are coming from someone who lives in a different country, it is especially important to disclose this to the lender initially as there may be different guidelines to be met.
Another form of accepted downpayment is a gift of equity. This occurs when a property is being bought and sold between related family members. The selling party gifts a portion of the equity to the buyers as a downpayment, meaning no cash changes hands while the mortgage finances the rest of the home value. These types of transactions tend to come with a few more requirements, do ensure you find out the details upfront.
If you’re considering this option, I recommend investigating it carefully as it can be difficult to build equity when effectively borrowing 100 percent of the home value. Depending on your specific financial situation, this option may or may not be for you.
When borrowing the downpayment funds, the new monthly payment for that debt must then be factored into your debt servicing. As an unsecured line of credit is most commonly used for a borrowed downpayment, you will be asked to provide confirmation that there are sufficient funds available for borrowing.
As the lender is not requiring the full 5 percent minimum downpayment from your own resources, you will likely still be asked to show the lender you also have funds in your bank account to cover the closing costs. This will be at approximately 1-1.5 percent of the purchase price and will include legal fees, any property tax or interest rate adjustments, and other miscellaneous moving expenses. For example, if your purchase price is $300,000, you need to show the lender you have at least $4500 available to cover such closing costs. Talk to your mortgage professional about the specific requirements and supporting documentation your lender will be looking for as the closing costs can be calculated differently depending on what province you are buying in and at what time of the year you are buying.
A less common version of a borrowed downpayment I want to mention is seller financing or a vendor-take-back mortgage. This type of financing is exactly as it sounds in that the seller agrees to take less money at closing and instead finances your downpayment or a portion thereof. It is important to be aware of the many restrictions that come with this type of financing. If you’re exploring this route, you could still be asked to show some investment into the purchase from your own funds, so be sure to have a preliminary chat with your mortgage professional about how you would like to structure your mortgage.
There are many eligible downpayment options and you don’t have to pick just one type, you could have a combination of some or all of the above. Whatever route you’re taking to home ownership, reduce your stress by talking with an experienced mortgage specialist and getting a head start on the document requirements. You want to prevent surprises during the home buying process when it comes to one of the most vital components of qualifying for a mortgage to purchase a home.