I have noticed “no downpayment” or “100% financing” used to be more common than it is now, though, it is still available with some lenders. Whenever I’m asked about it I think of the old adage, ‘just because you can, doesn’t mean you should’. Borrowing your downpayment in addition to qualifying for 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 the details of this product offering.
There are a few options available when borrowing your downpayment. The first one is to borrow against an asset; which 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 option is ‘unsecured’ borrowings such as from credit cards, personal lines of credit or a loan taken from a bank or credit union. The third option 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 or as a lump sum once you’re able to refinance the property.
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 or 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. Be advised some lenders are now also asking for proof of the source of the funds from the individual who is gifting the funds.
If you have any questions as to whether your funds are eligible for downpayment consideration do 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 as 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 restructure some of your debt and 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, after you pay down the debts, make sure you don’t charge them up 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. 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 explanation 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 reserve if something happens to your income and you have to fall back on your savings.
Bottom line, I believe it’s a good idea to borrow your downpayment if it improves your situation and/or helps you achieve a goal. Read all the fine print and ask questions in order to fully understand how much you will be paying every month. Don’t forget about costs in addition to your mortgage payment such as the payment for the downpayment loan, property taxes, power, water, internet, insurance, home maintenance, and more. 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.
If you have mortgage questions, contact Jackie at 780.433.8412 or firstname.lastname@example.org. Stay in the loop by following on Twitter @mortgagegirlca.
*Calculation is based on a $400,000 purchase price, 5% downpayment, $65,000/year income, $300/month existing debt payments and a 5-yr fixed rate at 2.49% at a 25-year amortization.