No Money Down

Mortgages[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.

4 comments

  1. What you say makes all kinds of sense, but I have a couple of points to clarify.

    With a 0% downpayment mortgage, the bank gives you the 5% downpayment for free. This is yours to keep as long as you stay with the same bank for the entire amortization period. Their bonus to you, I guess, for spending 150k or more in interest over the course of your mortgage. This means that your actual mortgage payment is (almost) identical to the one you’d be making if you use your own savings for the downpayment. The only difference would be the CMHC fee (which is 2.9 instead of 2.75). This amounts to $300 on a $200,000 home.

    Also, generally the GST price for a new home is included in the cost quoted by a builder. Most builders right now are offering a 1% rebate on all of their homes that have a closing date after July 1st (since their current prices have 7% GST included).

  2. Right, GST is included in the builder quote, but not in the value of the house. If you buy a house valued at $200k and the builder quotes you $206k because they included GST, that’s good and honest of them to do so, but you still end up with a mortgage of $206k on a house worth $200k (again, notwithstanding the other fees rolled in). As I said too, nothing about GST on new homes is specific to 0% downpayment, the 0% downpayment just ups the likelihood that when all is said and done, your mortgage will amount to more than your house is worth. It’s not the size of the mortgage payment that would keep me up nights there, it’s assuming thousands, or tens of thousands, of dollars in debt beyond what my house’s value can offset. Which is fine as long as nothing goes wrong since, in the long run, the house will go up in value and you will pay the mortgage down.

    If you have to sell for some reason though, now you have a mortgage balance that exceeds your home’s worth, plus you have realtor costs, plus you are now breaking the mortgage and hence not staying with the same bank for your entire amort, so they will come a knockin for any handouts they may have supplied. That sounds like a world of hurt.

    Additionally, I never met a bank that gave away tens of thousands of dollars without a hook. Maybe they cope with it by being less flexible on interest rates or elsewhere, I’m sure it varies from bank to bank, but I would have a real hard time swallowing a five-figure gift from a bank that claimed to be string free.

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  4. As an ex-banker — actually, I was a Mobile Mortgage Manager (outbound lending officer in US jargon), I can assure you that the concept of “giving away tens of thousands of dollars” is not quite what it seems on the surface.

    In reality, there are two dynamics at play :

    Firstly, lets say the loan was for $450,000: even at 6.50%pa (“I wish”) the sum total of all interest paid over the life of the loan would exceed $600,000, making the total amount of principal and interest paid in excess of ONE MILLION DOLLARS!!!!!!!

    Secondly, the foreclosure stats show (despite alarmist media releases) that the calculated risk in lending ‘over and above’ the asset value on a very small (relative to the total lending book) number of properties is a “risk” slightly less meaningful than the possibility of the moon spinning out of orbit at 3.34pm tomorrow afternoon and crashing into the Pacific Basin:):):)