Does it ever make sense to borrow money for a down payment?

Borrowing for a down payment on a home means one of two things: you currently don’t have enough money to meet Canada’s minimum down payment requirements; or, you need to pad your existing savings with a loan so you can afford a bigger down payment.

So the question is, should you borrow money for a down payment?

Unfortunately, there’s no easy answer because the decision is joined by a few other dilemmas.

On the one hand, borrowing the funds can help you put together a bigger down payment and get out of paying pricey mortgage insurance premiums. But on the other hand, getting a down payment loan means taking on more lines of debt and a potentially higher mortgage rate. You also need to be cognizant of affordability — are you adding to your debt load unsustainably? 

So, what do you do?

Consider your motivations for borrowing

Why do you want to borrow the money? Identifying the reason (or reasons) will help you see and evaluate the bigger picture. Is this part of a savvy financial strategy or an indication that you’re not ready for the market?

Here are some of the main motivations for borrowing for a down payment.

You really, really want to get into the housing market — like, right now

In the eyes of a hopeful homebuyer, today’s low interest mortgage rate environment is too tempting to pass up. You want to get in while the rates are low — especially before home prices get any more expensive. You plan on making it work because property is an important investment tool. It’s tangible and for many Canadians, it’s a form of forced savings. Plus, you’ve always wanted to be a homeowner. But, is getting a loan on top of your mortgage the best way to do that?

You want to put down 20% and avoid CMHC insurance (mortgage insurance)

Any down payment less than 20% leaves you on the hook for CMHC insurance (or mortgage insurance), which you’re legally required to pay. According to the CREA, the average cost of a Toronto home in February 2017 was $875,983. The minimum down payment for a home of that price would be $62,599 (based on Canada’s down payment rules), which would lead to a mortgage insurance premium of $32,535. If you’ve done the math on your dream home (I used this CMHC calculator), you know this premium isn’t small change and you’d rather pay more up front to avoid it. If you get a loan and put down 20%, you’re totally exempt from this premium.

You don’t want to put all your savings in one basket asset

If you fund your down payment on your own, you might end up house poor. Buying a home is no small feat — it can literally drain all of your assets. And then what? You’ll still have mortgage payments, ongoing household bills, and general living expenses knocking on your bank account door. So instead of pulling out all your savings, you’ve decided that getting a loan is a safer route to homeownership — this way you can buy a home and still have some money tucked away.

Be prepared for the ripple effects and larger consequences

Borrowing money for a down payment has its benefits, but it also comes with many, many caveats. I spoke with mortgage broker and owner of MonsterMortgage.ca, Vince Gaetano, who warns that borrowing really only makes sense if the loan terms are reasonable. Like the kind of terms usually set by the bank of mom and dad.  

“Parents and family are the best sources to borrow funds”, says Gaetano. “They are primarily looking to help.”

But for those of us who can’t turn to our parents or a fabulously generous aunt for a family loan, Gaetano asks us to be very careful when seeking a down payment loan.

Remember to give your mortgage lender full disclosure

Gaetano says you must tell your primary lender — the bank or broker offering you a mortgage — that you’re getting a down payment loan.

“Some lenders will restrict any form of secondary financing and want to make sure that the down payment comes from the borrower’s own resources,” Gaetano explains. In that case, “full disclosure is important to avoid any closing day delays or disappointments.”

If your mortgage lender does allow for secondary financing, you’ll have to open up about the details of the loan: how much are you borrowing, at what rate, and how long is the term? Your mortgage lender has to cover its own butt first. It needs to assess whether or not you’ll be able to service its loan in tandem with your additional loan.

Bigger down payments can lead to higher mortgage rates

Terribly counterintuitive, but true. If you’re borrowing money to scrape together a bigger down payment that sidesteps CMHC insurance, consider this: insured mortgages typically qualify for lower mortgage rates.

CMHC insurance protects the lender, not you, so the logic here is simple. An insured mortgage is backed by the government, which means the risk of default is lower. You may have assumed that a 20% down payment would make you look less risky and more financially stable, but it doesn’t. Not to a bank. So unless you’re prepared to aggressively pay back your mortgage, perhaps a down payment loan is a bad idea.

How much debt can you actually live with?

If you have to throw a mortgage loan, a down payment loan, plus your own cash at a home, is this a good idea? Financial planner Joe Barbieri says probably not.

“If you have to borrow for the down payment, what is going to happen when the other house expenses start rolling in?” Joe wonders. “You will have to be able to generate extra money consistently to afford buying a house.”

So his advice is to think long-term and wait: “If you can do this [earn extra money], you can save for the down payment — it will just take a little longer.”

Plus, Gaetano cautions that “Secondary financing is more expensive to arrange due to additional lender fees, legal fees, and shorter length of terms, making them quite cost prohibitive if they are not paid out quickly. Be aware of all the additional costs.”

Circle back and weigh your options

Now that we’ve walked through the question — does it make sense to borrow money for a down payment? — it’s time to sit down and think through the decision.

Facts to remember

1. A bigger down payment gets you out of paying CMHC insurance.
    
2. A bigger down payment and an uninsured mortgage can result in a higher mortgage rate.
    
3. A separate loan helps you protect some of your savings, which you’ll need to cover your costs, post-mortgage.

Questions to chew on

1. If you can’t afford a down payment on your own, are you ready to enter the market or are you about to get in over your head?
    
2. Will your mortgage lender accommodate other loans?
    
3. How much debt can you responsibly take on?

Other options to consider

1. Family loans: We discussed this briefly and while family loans aren’t an option for everyone, wouldn’t life be swell if they were? “We are seeing family-type loans more often than usual and this is primarily due to the tighter qualifying guidelines,” says Gaetano. In this scenario, the buyer “avoids being burdened with the trilogy of fees that come with arranging secondary financing.”
    
2. Your RRSP: To many, this money is strictly off limits. But Barbieri reasons that withdrawing from your RRSP to cover your down payment can be a better alternative to a loan; it’s your money and it’s interest-free. And perhaps investing in real estate is a better retirement strategy anyway.

Hopefully this cheat sheet of questions and takeaways helps you decide. When you figure out your best option, maybe you can tell us about it some time. Unless you did indeed find a rich aunt to fund your dream home — then we’re just jealous.