This topic has been on my mind after seeing and hearing about it recently. It immediately reminded me of the old adage, ‘just because you can, doesn’t mean you should’. Borrowing your downpayment in addition to getting a mortgage can be a risky undertaking if not done responsibly. The optimal way to decide if you should borrow your downpayment is to ensure you fully understand what comes along with doing so.
There are a few routes you can take in borrowing your downpayment. One option is to borrow against an asset; this is referred to as ‘secured’. This would involve the refinance of a rental property, a home equity line of credit or a loan secured against investments. Another source is ‘unsecured’ borrowings such as from credit cards, personal lines of credit or a loan from a bank or credit union. The third source is seller financing or a vendor-take-back mortgage. This is where the seller of the property you are buying from takes less cash upfront and effectively carries a 2nd mortgage for you which you agree to repay on a monthly basis.
Can You Qualify
Your existing monthly debt payments are taken into consideration when calculating the maximum mortgage amount you can borrow. If you borrow for your downpayment, the monthly payment on that debt will now be factored into your debt ratios for your new mortgage. Depending on your income, this can decrease the maximum mortgage amount you can qualify for. For example; let’s say you borrow $20,000 with a minimum monthly payment of $600. Your maximum mortgage amount could decrease by up to $120,000*, versus if you had the 20K from your own savings.
While borrowing your downpayment is an option, it is not the only one. There are numerous downpayment sources that are acceptable to our lenders. This includes, but is not limited to;
From Own Resources– this is when you have saved up your downpayment funds and can show a 90 day transaction history of accumulation of those funds to the lender. Most common sources are a savings or chequing account, RRSPs, investments and a TFSA.
Gifted– most lenders will allow downpayment funds to be gifted from an immediate family member. They usually only ask for proof of funds via a signed gift letter and confirmation of deposit of those funds into the borrowers bank account. Do be aware some lenders are also asking for proof of the source of funds from the individual who is gifting the funds.
If you have any concerns, your best bet to find out if your funds are eligible for downpayment consideration is to have a chat with the mortgage professional you are working with.
When Borrowing Your Downpayment Is a Good Idea
I’m not going to say that borrowing your downpayment is a bad idea as there are definitely situations where it’s a benefit to the borrower. How to determine when it’s in your best interest is a bit tricky though and there are a few factors to consider.
When thinking about potential downpayment sources, be sure to take your long-term goals into consideration. When you borrow your downpayment and in turn have an additional monthly payment to make, that could severely restrict your ability to reduce your mortgage principal and build up your home equity. If paying down your mortgage is a priority for you, make sure the payment on your downpayment loan fits into your budget or maybe you should consider an alternative downpayment source.
If you are using a borrowed downpayment along with some of your own cash as a tool to also restructure some of your debt and perhaps even reduce your overall monthly payments, that may be just the right way to buy a house at this time in your life. Having said that, make sure you don’t regress and rack up the debt again. When borrowing additional money to buy a home make sure you have a solid exit plan to reduce your downpayment debt in a hurry as I believe borrowing this money is okay to do in the short term, though potentially pricey in the long term. Without going into a long spiel about financial planning, don’t get distracted by the appeal of home ownership unless you are truly “financially” ready. Only you can make that decision. Lastly, make sure after buying a home you can still maintain a cash cushion if something happens to your income and you have to fall back on your savings.
Bottom line, it’s a good idea to borrow your downpayment if it improves your situation and/or helps you achieve a goal. My tip if you choose to pursue this route is to make sure you know what you’re committing to. Read all the fine print; ask the questions you need to fully understand how much you will be paying every month and don’t forget about the costs over and above your mortgage payment such as the payment for the downpayment loan, property taxes, heat, internet, insurance and home maintenance. If this is your first home, it is that much more important that you do your research so you’re not blindsided by the unexpected.