[This really isn’t an article for one person, but there’s one person out there who will think it is about her, and in a way it is – if she weren’t talking about this then maybe I wouldn’t be thinking about it and writing about it just this very second. Nothing in here is specific to her situation though, and with money it’s almost always about the specifics of your situation, so grains of salt all round.]
So you want to buy a house. Great. I’ve already written about that. Basically I think it’s a good idea. Certainly in the long run it’s a good idea for most people – it’s a forced savings vehicle that tends to beat inflation, and it’s also a roof and a fridge and faucets and other things that make life more comfortable. Yay houses. One of the things I glossed over in that article, though, is the question of downpayments, or more specifically their absence: no money down mortgages. You all know that I am not someone to let glossings-over stand.
First, a refresher: banks don’t like risk, so it used to be that they would only write mortgages for people with 25% or more as a downpayment. This made it very difficult for working stiffs to buy houses, but the banks were happy because their default (a.k.a. skip town in the middle of the night) rates were low; people able to slap 25% of a house’s value down on the table can generally come up with the other 75% in due course. In order to help out the working stiffs though, the government created an insurance company, the CMHC, to convince banks to lend with smaller downpayments by offering to insure the mortgages against default. You can now get a mortgage with as little as 5% down, and in exchange you pay a fee to the CMHC to insure your mortgage in case you decide to stop paying, and everybody’s happy. If you push it all the way down to 5%, the fee gets pretty hefty (2.75% of the house value, so $5500 on a $200k house) but that’s still easier to swallow than putting together a $50,000 downpayment.
Last year the CMHC decided to lift the requirement that your downpayment, now as little as 5%, be unencumbered. Until then, you had to prove that the 5% downpayment was not borrowed money, that you legitimately had some savings. This sanity check kept people from paying for downpayments on credit cards and the like. Why? Because a) it’s not a very wise move on your part, and indicates that you might not have the financial resources to be buying a house; but also (from a less nanny-state point of view) b) this behaviour strongly suggests that you are not a very safe mortgage risk. The CMHC scrapped the sanity check because an environment with historically bargain basement interest rates, and a housing boom, and a generally healthy economy, is one where they wanted to reduce the barriers that even 5% could create. They could have just dropped the minimum downpayment to zero; instead they left it at 5% but let you borrow — this way you have to at least convince someone to trust you with credit.
Banks have stepped in now to fill in the blanks, with all of them trumpeting no-money-down mortgages for people who, to quote one bank site, “can’t seem to save for a downpayment” – as though saving for a downpayment is like finding your car keys. “I’ve looked everywhere, but I can seem to find $18,000.” They bundle up the whole process so that, on paper, you are getting a 95% mortgage and a 5% loan which they then use as your downpayment (ideally without your grubby little paws ever touching it). You end up with a mortgage balance of 100% of your home’s value (95% + 5%) plus the CMHC fees which you presumably just added on top, plus potentially other things like GST if it’s a new house. To make this concrete then, if you buy a new $200,000 house, your mortgage balance on day 1 will be around $217,500 (100% mortgage + 2.75% CMHC + 6% GST after July 1) – give or take any extra fees or discounts or what-have-you.
First reason why this is not the best idea: $217,500 > $200,000. Of course things like GST on new houses happen whether you do 0% downpayment or not, but by putting absolutely no money down up front, you create — you guarantee — a situation where your debt exceeds the value of the thing securing it. If you had put 10% down in the same scenario you’d be close, but still under the market value of your house (also at 10% the CMHC fee drops to 2.0%, saving you $1500). This is not just an academic problem – if something should happen and you need to sell, there’s a big difference between “Damnit, we put $20,000 of savings into our downpayment and now it’s all gone” and “Damnit, where are we going to get $20,000 immediately, because selling the house didn’t pay off our debt!”
On the other hand, if everything goes smoothly and no one loses their job or gets hurt or gets transferred to another city or needs to go part time to take care of a family member and if the real estate market stays up and if your pay doesn’t get cut and if– in general if nothing unexpected happens, then in a couple years the mortgage will come down towards $200,000 and the house’s value will go up, and you’ll reach a point where you can sleep at night. Everything I said before about how houses act as forced savings vehicles that beat inflation still applies – in the scenario where you’re sure nothing will go wrong, 0-down mortgages are a perfectly fine idea. You get a house for free, your rent payments become mortgage payments, and you start building equity. Bully for you. As long as nothing goes wrong.
A downpayment isn’t just peace of mind for the bank – they aren’t losing sleep here – it also gives you some security, some wiggle room. According to TREB, the average list price of a house in 1989 was $273,698; 7 years later in 1996, it was $198,150. A 5% downpayment isn’t going to save your butt there, but putting yourself $20k farther behind because you wanted a house nownownow isn’t going to help either. I said at the beginning of this post that, as with most money things, mortgages are all about the details. If careful evaluation argues that it’s right for you to go into a 0-down mortgage, then I’m not going to tell you different, and all of this is jmho anyhow. But I wouldn’t do it personally; I value my sleep too much.