To purchase a home, there are two common ways this can be done. You can either buy with all cash, or you can secure a mortgage to form part of the purchase price. Leases are broken up into two categories which are high ratio and low ratio. A high ratio mortgage is where the mortgage amounts to 80% – 95% of the purchase price. A low ratio mortgage is a mortgage which is below 80% of the purchase price. Whatever percentage the lease amounts to, you are required to provide the remaining funds to equal the full purchase price. This is called your down payment. Down payment can be provided in the following ways:
- Your resources
- A gift from a family member (depending on the loan value, some lenders won’t accept this as they want you to provide the funds for your resources)
- A loan which is secured by another piece of real estate
- A Line of Credit
Something to keep in mind is when you borrow your down payment through securing a mortgage or obtaining a line of credit; your property is now 100% financed. Even though all of the financings are not directly associated with the property, this is something to be conscious of. Although 100% financing used to be an option, it is now primarily extinct, and there is a very valid reason for this. The problem with this type of funding is if your home value slightly drops, you are now sitting in negative equity.
Down payment also consists of another part, which is called your real estate deposit. The real estate deposit is to be provided once all subject to clauses have been removed or fulfilled on your accepted offer to purchase. This usually happens about 1-3 months before the actual purchase date, as a sign of intent to purchase, as well as making it a firm and binding contract to purchase. The deposit which is required to be paid in advance should equal 5% of the purchase price and will form part of your down payment.
- $500,000 purchase price
- $400,000 mortgage (80% loan to value)
- $25,000 deposit (5% of the purchase price)
- $75,000 down payment, bringing your whole down payment to $100,000 ($25,000 + $75,000) to form the whole purchase price.
In cases a new build/development is being purchased, the deposit may need to be provided six months or more in advance and most cases, is required to be 10% of the purchase price.
Where is this deposit paid to?
Depending on how the contract is structured and what the purchase is in regards to, the deposit should be directed to the following:
- Arm’s length purchase – A purchase where the buyer and seller have no direct relationship with each other, they are acting in their self-interest and the price paid is indicative of fair market value. In this type of purchase, the deposit is usually made payable and held in the buyer’s Real Estate Companies trust account.
- Norm’s length purchase – A purchase where a buyer and seller have a direct relationship with each other and the price paid is not indicative of fair market value. From is typical with a parent selling to a sibling, and this is also known as a private sale. In this case, the deposit is usually made payable to the vendor’s solicitor, or directly to the seller.
- A new build – With a purchase of a new build, the deposit is usually made payable to the vendor’s solicitor.
Important note – First time home buyers program
If you are a first time home buyer searching for your new home and struggling to save your down payment, you may want to take a look at the BC Home Owner Mortgage and Equity Partnership Program (HOME). This is a government grant and assistance program for the residence of Canada trying to purchasing their first home in British Columbia.
How the program works
Whatever amount of down payment you put down from your resources, the Government will match. You will receive a maximum grant of 5% of your purchase price up to $37,500. This program is only available for purchase prices that are under $750,000.
- You are a first time home buyer who has now owned an interest in a property anywhere in the world.
- You must use the property as your principal residence for the first five years.
- You are a Canadian citizen or permanent residence for at least five years.
- Have resided in British Columbia for at least one year before the date of application.
- You are obtaining a high ratio first mortgage on the property. This means you need to obtain a mortgage above 80% of the purchase price.
- The gross combined income of all household individuals does not exceed $150,000
This is an excellent program if it is efficiently utilized. This loan has a 25-year amortization with the first five years being interest and payment free. After five years you will be paying this loan back at a rate of RBC’s prime rate + 2%.
The way we look at this loan is that it’s a great way to get first time home buyers into their first home, but it should not be used to keep them there. The first five year grace period should be used to budget and save accordingly, so you are in a position to pay the loan back in full upon five years. If you elect not to do this, you are now making mortgage payments and payments on a HOME loan which may have an interest rate equal to or higher than your mortgage.
This program was introduced in early 2017. Although the way mentioned above would be the ideal way to utilize this program, there will be people who choose not to and others that don’t have the resources to do so. 2022 will be the first year of the grants starting to bear interest so we will stay tuned to see how the first time home buyers chose to handle their finances.
How do I borrow money for down payment?
Simply and directly put, you need to own another piece of real estate and have excellent and stable income.
Borrowing from Real Estate
A lot of the time people borrow money on their primary residence to provide the down payment or buy flat out if they have enough equity on an investment property, vacation property or second home. Since everyone has a different situation, it’s always important to get in contact and discuss your options with a professional. There are many factors to take into consideration, and a product that suits one’s needs may not be ideal for the next.
Some things to consider if you are planning to own two homes:
- Property taxes that will be payable on both homes
- Heat fees
- Condo fees (if applicable)
- Property transfer tax
- Closing costs
- Two mortgage payments you will be making.
- Your qualifying ratios
- Mortgage penalties if you are planning to refinance
- If you are buying a rental property consider vacancy rates.
Note – If you are planning to buy another property and renovate, an excellent product to look into would be a Home Equity Line of Credit (HELOC). A HELOC is a revolving line of credit that is secured by your home. The product resembles that of a large credit card meaning you can borrow up to your limit, pay it off and borrow again. Since you only pay interest on the amounts you borrow, this is good for people who need increments of money to pay for trades and only want to pay interest on smaller amounts of money.
Line of Credit (LOC) – Unsecured
A line of credit has the same concept as a HELOC, but the main difference is that this is an unsecured loan. With a line of credit, having good income is essential. Not only income but having proper credit is also a must. Because this loan is not associated with a physical asset (secured against a piece of real estate), the lender wants to make sure you are a high-quality borrower. This means you have the required income to repay the loan, and you have a credit score that is indicative of you repaying the loan.
Although receiving a line of credit large enough to cover your entire down payment may be quite unlikely, you still may be able to receive an amount that is significant enough to cover a portion.
If you are a business owner with constant revenues coming in, you may be able to receive a business line of credit. This loan would be based more on the criteria of your business and less on you as a borrower. This is not to say that you as a borrower will not be considered.
Selling your current residence to buy your next home.
A more common scenario is one where someone is selling their current residence to purchase a new home, and the down payment is coming from the proceeds of their sale. In some cases, which is familiar with seniors downsizing, their sale proceeds (equity) will be used to purchase the whole home, so no mortgage is required.
In when someone is selling to buy a new home, what they will try to do is carefully align both the purchase and sale dates. By reducing the time between the two, this enables them to transition from one home to the next smoothly. This is the most desired method because if the dates were spread a month or two apart, it would force them to rent or find somewhere else to stay in the gap. Creates extra moving fees, more time spent moving, rental fees, possible storage fees, and a more significant headache than necessary.
While a tightly aligned purchase and sale dates are the optimal situations, there is a problem that arises. The deposit. As mentioned above, the deposit is to be provided anywhere from 1-3 months before the actual purchase date. Since the majority of their money for the down payment is currently tied up in their equity, which they can only access once their home is sold, there becomes a gap where deposit funds are needed, but unable to be provided. If this is the situation you are in, you will have to secure service like Deposit Financing which can help provide deposit funds on your behalf.
This problem does not happen most of the time with down payment. Because the down payment is to be provided on the actual purchase date, you should receive your sale proceeds by then, enabling you to provide the necessary down payment.
If you are buying you sell, you will have to look into bridge financing. Bridge financing is a loan that is associated with the property you are selling, but the proceeds are used towards the property you are buying. This is an excellent way to gain access to your sale proceeds before you sell your home. Although buying before you sell is not ideal, it tends to happen often in hot real estate markets where time is of the essence and purchase and sale dates are not able to be lined up accordingly.
Many products are always added to and taken away from the market. To educate without overwhelming, this blog has been kept short and only focused on a few of the more common options. If you want to know more about your options and what may be available to you, you should get in contact with an industry professional.
Deposit Financing Canada
Categorised in: Loan Agency
This post was written by zack