As your home purchase will most likely be the biggest (most expensive) acquisition of your life, you’re going to need to know exactly how much money you should have, and where it is going to go. Having enough funds for the down payment is only the first part you need to factor in when buying a home, you also need to consider: closing costs, your deposit, home insurance, and possible CMHC insurance - depending on how much you have to put down on the home. Read on to see exactly how and why money matters in your real estate transaction as a first time home buyer.
HOW MUCH DO I NEED, AND WHY?
I’m going to tell you right now that you’re going to need to have saved at least 10% of the price of the home before you are ready to buy. I can already hear you, “but Nicole, the banks only require 5% as a down payment” – (if you think this you are already on the wrong track, unless you are looking at only spending less than $500K, but we’ll get into that later). Even if the bank only did require 5% as a down payment, there are many other costs you will need to factor in. Read on to see exactly what you need for each step of the process:
As of December 11, 2015 Finance Minister Bill Morneau announced that there would be a policy change in the way the banks accept down payments for mortgages. Previously, 5% down would have been enough to get you into the market, but with the new rules, that has changed.
The new down payment rules are as follows: you must provide 5% of the purchase price as a down payment for sums up to $500,000, and 10% for anything thereafter.
Let’s break this out into an example:
You want to buy a $650,000 home in the Toronto area. How much would you need for a down payment?
5% on the first $500,000
10% on anything thereafter
So, let’s figure out the first part: $650,000 - $500,000 = $150,000.
5% on the first $500,000
= $500,000 x 5%
10% on the $150,000 (to make $650,000)
= $150,000 X 10%
Adding these two together gives you the total down payment required, at $35,000.
Now this 5% + 10% after $500K down payment is the minimum amount that you are allowed to put down. When you put down the minimum, you must also be prepared to pay for mortgage insurance. Mortgage loan insurance is typically required by lenders when you have less than 20% to put down on the purchase of a home – going with our example above, for a $650,000 home, the down payment required at 20% would be $130,000. Being first time home buyers trying to get into the Toronto market, we know it can be difficult to get to this amount (unless you have a loan from the very gracious Bank of Mom and Dad), which is why you will most likely need to purchase insurance from the Canada Mortgage and Housing Corporation.
This loan insurance is put in place to help protect the lender against default (in case you are unable to pay your mortgage), and allows you to purchase a home for a higher value without having the full 20% down. The premium is based on a percentage of the home’s purchase price that is financed by your mortgage, and can be paid in a lump sum, or can be added to the value of your mortgage owing to the bank.
The exact cost of the CMHC insurance will be given to you by the bank, but here are some general rules:
- It is calculated as a percentage of your loan
- It is based on the size of your down payment
- The lower the down payment, the higher the premium, and vice versa
Price of Home: $650,000That being said, if we take our first example of the $650,000 Toronto home, with the minimum amount down, the premium would work out to be approximately the following:
Down Payment: $35,000
Down Payment Total Percentage: $35,000/$650,000 = 5.38%
Premium Based on a 5.38% Down Payment: 2.4%
Total Loan Value: $650,000-$35,000 = $615,000
Total Premium in Dollars: $615,000 x 2.4% = $14,760
Disclaimer: These values are approximate based on the table information gathered from https://www.cmhc-schl.gc.ca/en/co/moloin/moloin_005.cfm, and in no way are claiming to be an exact representation of what will be billed as a loan insurance premium. Please check out the Canada Housing and Mortgage Corporation website for more details at https://www.cmhc-schl.gc.ca/en/co/moloin/.
A lot of people wrongly assume that the down payment and their deposit are synonymous. Unfortunately, this is not the case – the down payment is for your mortgage, and the deposit is money you will give the seller’s agent to hold as a gesture of good will and intention towards the home purchase. The deposit can be given in two ways, either with the offer, or within 24 hours after the offer is accepted – the way you give the deposit will be outlined in the Agreement of Purchase and Sale.
There is no set amount that you must give for the deposit, but in Toronto the going rate is usually 5% of the home purchase price. That is not to say that you must give 5%, but having a larger deposit makes your offer more attractive to the seller, and with a hot market such as Toronto, anything you can do to help you stand out may win you the home.
Let’s take our previous example of the $650,000 Toronto home – for this offer it would be customary to provide a $32,500 deposit in the terms of the Agreement of Purchase and Sale.
NOTE: I have seen this time and time again, and unfortunately sometimes buyers just do not have the cash available when they find their perfect home. Not that they do not have the cash for the deposit, the key word here is available. If you have your deposit, say, tied up in RRSPs, there can be a waiting period before you can actually get your hands on the cash – and if you don’t have that available when you want to make your offer on the home, it can lose you the negotiation. I tell all my buyers this: things move quickly in the Toronto market, and if you want to remain competitive (which you should), you must have your funds available to you at the drop of a hat – you never know when your dream home could come up, and you don’t want to lose out because of a 24 hour holding period.
As a rule of thumb, I tell my clients to ensure they have at least 2.5% of the purchase price saved to cover closing costs. What are closing costs, you might ask? They can be broadly broken down into the following:
- Legal Fees
- Property Tax Adjustment
- Interest Adjustment
- Legal Fees
As the Agreement of Purchase and Sale is a binding contract, you are going to require the assistance of a Real Estate Lawyer to help you through the legal aspect of the process. As with everything in life, this too will cost money on top of the purchase price of the home. You can expect to spend anywhere in-between $1000 - $2000 on legal fees, which covers: the lawyer themselves, disbursements on the mortgage, completing a tax certificate, registering the charge (mortgage), and completing the property title search.
A great resource to calculate closing costs in Toronto can be found on the O’Neil Advisors webpage, at http://oneilladvisors.ca/services/closing-costs-calculator/#. You just pop in your purchase price, indicate whether or not the home is in the City of Toronto, and add in your other fees and it will give you an approximate number.
PROPERTY TAX ADJUSTMENT
When you purchase an existing home, it’s possible that the previous homeowners prepaid portions of the property taxes on the home. If this is the case you will need to reimburse them the money that they paid as of the closing date on the contract.
How is this calculated? Say for instance the property taxes on the home are $3,600 per annum and have been prepaid by the previous homeowners. Now let’s also say that your closing date is September 1st – September is the 9th month out of the 12 month year, so the math would be simply:
$3,600 / 12 months = $300 per month
12 months – 8 months (when the previous owners lives in the home) = 4 months
4 months x $300 per month = $900 owed to the previous homeowner for the prepayment they made on the property taxes for the home you purchased.
Typically mortgages are calculated for payments on the first of the month, but if your closing date is on a date other than the first, it may differ from the date your mortgage actually starts. If this is the case, your lender may put an interest adjustment date into effect, and you would need to pay interest for the time period prior to your mortgage start date. This seems a little complicated, so let’s look at an example:
Let’s say you have a closing date of March 15th, but your mortgage start date is April 1st. You will need to have the money prior to the mortgage start date in order to pay the seller, but you will also need to pay interest on the days prior to the start date that you had the money.
If the total amount borrowed for the mortgage = $615,000, and you received these funds to transfer to the seller on March 15th, then you would need to pay interest on the days leading up to the start of the mortgage on April 1st. There are 16 days between March 15th and April 1st, so the amount of interest you would pay would be equivalent to 16 days’ worth.
THE OTHER 2.5%
If you’ve worked through all the information I’ve provided you with above, you will notice that we are only at 7.5% of the 10% I said that you would need. Technically, you have covered all the musts with 7.5%, but there is room for error in those calculations, and you never know when an unexpected expense might come up. Your home is most likely the most expensive purchase you will ever make, and it is better to be safe than sorry. That extra 2.5% could be used for repairs needed in your new home, to help with moving costs, or to purchase extras like curtains or put up a fence. You never know until you know, and it’s best to be prepared for the what-ifs.