Mortgage Down Payment Options
From a low down payment mortgage to using your Registered Retirement Savings Plan (RRSP) as a source of funds, buying a home has never been easier.
The down payment is that portion of the purchase price you furnish yourself. The balance is obtained from a financial institution in the form of a mortgage. The amount of the down payment (which represents your financial stake, or the equity in your new home) should be determined well before you start house hunting.
A conventional mortgage requires a down payment of at least 20% and is offered on either a fixed or variable interest rate basis. Conventional mortgages have the lowest carrying costs because they do not have to be insured against default.
Low Down Payment Insured Mortgage
Most lenders now offer insured mortgages for both new and resale homes with lower down payment requirements than conventional mortgages-as low as 5%. Low down payment mortgages must be insured to cover potential default of payment; as a result, their carrying costs are higher than a conventional mortgage because they include the insurance premium.
Mortgage default insurance is a one time premium paid when your purchase closes. You can pay the premium or add it to the principal amount of your mortgage. Talk to your mortgage specialist to find out which option is best for you;
Using Your RRSP as a Down Payment
Under the federal government’s Home Buyer’s Plan, first-time home buyers are eligible to use up to $25,000 in RRSP savings per person ($50,000 for couples) for a down payment on a home. The withdrawal is not taxable as long as you repay it within a 15-year period. To qualify, the RRSP funds you plan to use must have been in your RRSP for at least 90 days.
Even if you already have enough money for your down payment, it may make sense to access your RRSP savings through the Home Buyers’ Plan.
For example, if you have already saved $25,000 for a down payment-and assuming you still had enough “contribution room” in your RRSP for a contribution of that amount, you could move your savings into an RRSP at least 90 days before your closing date. Then, simply withdraw the money through the Home Buyers’ Plan.
The advantage? Your $25,000 RRSP contribution will count as a tax deduction this year. Use any tax refund you receive to repay the RRSP or other expenses related to buying your home.
However, the money you borrow from your RRSP won’t earn the tax-sheltered returns it would if left in your account. Ask your financial planner if this strategy makes sense for you.
CLOSED, OPEN AND CONVERTABLE MORTGAGES
Can’t decide between a closed, open or convertible mortgage? There are many factors to consider such as your financial goals and how soon you want to pay off your mortgage.
Closed term mortgages are usually the better choice if you’re not planning to pay off your mortgage in the short term. Interest rates for closed term mortgages are generally lower than for open term mortgages. Closed term mortgages offer you the ability to save on interest costs and payoff your mortgage faster. You will pay a prepayment charge if you wish to renegotiate your interest rate, prepay more than your mortgage allows or pay off your mortgage balance prior to the end of its term.
Convertible Closed Mortgage
A convertible mortgage gives you the same benefits as a closed mortgage, but can be converted to a longer, closed term at any time without prepayment charges.
Open term mortgages may be appealing if you are planning to pay off your mortgage in the near future. They can be repaid either in part or in full at any time without prepayment charges. Open mortgages can be converted to any other term, at any time, without a prepayment charge. Interest rates for open mortgages are generally higher than for closed mortgages because of the added pre-payment flexibility.
Fixed Rate Mortgages
The interest rate for a fixed rate mortgage is locked in for the full term of the mortgage. Payments are set in advance for the term, providing you with the security of knowing precisely how much your payments will be throughout the entire term. Fixed rate mortgages can be open (may be paid off at any time without breakage costs) or closed (breakage costs apply if paid off prior to maturity).
Variable Rate Mortgage
With a variable rate mortgage, mortgage payments are set for the term, even though interest rates may fluctuate during that time. If interest rates go down, more of the payment is applied to reduce the principal; if rates go up, more of the payment is applied to payment of interest. Variable rate mortgages may be open or closed.
A variable rate mortgage provides you with the flexibility to take advantage of falling interest rates and to convert to a fixed rate mortgage at any time.
Choosing the length of your amortization period, which means the number of years you will need to pay off your mortgage, is an important decision that can affect how much interest you pay over the life of your mortgage.
Historically, the standard amortization period has been 25 years. However, shorter and in some cases longer time frames may be available depending on the amount of down payment you have available.
A shorter amortization saves you money as you will pay less in interest costs over the life of your mortgage. Your regular mortgage payment amount would be higher than if you had selected a longer amortization, as more of your payment goes towards paying down your principal balance. However, the benefits are that you build the equity in your home faster and are mortgage free sooner.
A longer amortization provides you lower monthly payments and because of this it is appealing to many people. However, it does mean that more interest will be paid over the life of the mortgage and you will build the equity in your home at a slower pace.
What is a prepayment privilege?
Prepayment privilege is the ability to prepay a portion of the mortgage principal before it is due and without penalty. Prepayment is simply paying more than the monthly payment on the mortgage, with the extra amount applied to the principal.
Mortgages are usually paid on a monthly basis, according to an amortization schedule, and the mortgage holder profits by earning interest on the unpaid balance. When a borrower prepays a portion of the mortgage, the mortgage holder loses interest. Therefore, on many mortgages, there is a prepayment penalty.
The penalty can be substantial. In many cases, it can be up to 3 months of payments, or the interest differential of interest at the time of the prepayment minus the prevailing interest rate. Obviously, these are penalties a home buyer would like to avoid.
Types of Prepayment privileges
If you have a prepayment privilege, you can avoid these penalties. An open mortgage will have no penalties, so it carries prepayment privileges. Open mortgages generally carry a higher interest rate than closed mortgages, however.
Other mortgages may have a limited annual prepayment privilege. For instance, a mortgage may provide that 15% of the principal can be paid annually without penalty.
Buyer A has a $200,000 mortgage with a 5% interest rate and a 15% annual prepayment privilege. In the first year of the mortgage, Buyer A will be able to pay roughly $30,000 or 15% of the mortgage principal in addition to monthly payments.
These mortgages are good for people who have seen an increase in income since the mortgage was issued, and are able to add extra to their mortgage payment each month. They are also good for clients who like to apply an annual lump sum payment to their mortgage, such as a tax refund.
For those who have no desire, nor the means to prepay any portion of the principal during the term of the mortgage, they may consider looking at mortgages with limited prepayment privileges. There is a good chance they can obtain a better mortgage rate without having to pay for unneeded, larger prepayment privileges.
At Capital Mortgages, finding the right mortgage for you is important. We can discuss your current financial situation, as well as your future financial plans, to determine whether prepayment privileges are a mortgage term that is important to you.