saving for a down payment
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Saving for a down payment: should you buy now or wait till you have more saved? I have to admit right off the bat, I am a huge fan of getting on the real estate ladder as soon as possible. There is a reason it is called ladder, hinting you will be getting higher and higher, slowly one step at a time…

Let’s have a closer look at young family: Mary and Bob. They are newly married professionals, currently renting a nice apartment for $1200. They have been saving for a down payment and have $15,000 at their disposal. Now the whole extended family is debating whether they should buy right away or rent for another three years and save more for the down payment.

I am for Buying Right Away option. They like a cute starter home and the numbers run as follows:

House Purchase Price300,000
Down payment, 5%15,000
Mortgage285,000
Mortgage Default Insurance, 4%11,400
Total Mortgage296,400
Monthly Payment with 25 years amortization, 1.99% interest rate1,254
  
  

Yes, there is a rate like that – 1.99% at the time that this article is published. Also, please note that of $1,254 of the monthly payment, $490, will be interest payment and $764 will go to pay down the principal of the mortgage (this is like forced savings, as you are building your equity).

So, the real expense will be interest for the mortgage $490, property tax $200, utilities $200, for a total of $890. This is still less than the rent they paid. And the huge bonus is that typically property is increasing in value. In Canada its about 5% annually. Yes, there are ups and downs, but this is the trend and its upward. In three years the property can be worth $347,284. A huge gain of $47,284.

The Saving Some More option.

Say, uncle Ben is convincing you that saving for a down payment for a couple more years and buying when you have 20% down payment is better as you avoid paying a Mortgage Default premium. While saving a larger down payment may seem like a smart idea at first, there are a few big downfalls. Let’s look closer:

If you are saving $15,000 per year you will have to save for another 3 years to save the total of $60,000 (remember the couple has $15,000 already saved, plus $45,000 they will save in the next three years).

The first big downfall: during those three years, the couple will still need to pay rent while they continue to save. This can make for a very tight budget, unless, of course, they plan to move into the parent’s basement while they save.

The second big downfall is the lost opportunity cost of waiting. Yes, you will save $11,400 on the Mortgage Default insurance premium, but you will not gain from the property increase that will most probably happen in three years. In fact, you may end up paying more for the same property then you would have three years earlier. Based on the Canadian average increase used above, that 300,000 property could be selling for $347,284. Meaning that while the couple has saved an extra 45,000 down payment, they will have to spend an extra $47,284 to buy that same property instead of having enjoyed the equity that has been built in the home over those years had they purchased earlier! They will also need an extra $9000 in order to have a full 20% down payment!

House Purchase Price with 3 year average increase347,284
Down payment, 5%69,457
Mortgage277,827
Mortgage Default Insurance, 4%N/A
Total Mortgage277,827
Monthly Payment with 25 years amortization, 1.99% interest rate1,175
  
  

After three hard years of skimping and saving for a down payment, Mary and Bob’s actually monthly cost is only $79 less then it would have been had they purchased their home three years earlier. For me, its pretty obvious that the first option is financially more sound. The key here is to get affordable property and I would like to refer you back to the term “real estate ladder”, which also alludes to one step at a time. Start with a small property, upgrade every 5 years and you will be amazed with the growth of your equity over the years.

Please do not hesitate to contact us if you have further questions or would like us to run a few different scenarios for you.

Tamara Tkachuk, 416 859 0612, Bayviewfs.com

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