Is 5% Down Still Enough in Toronto’s Hot Housing Market?

It’s every home buyer’s worst nightmare: You’ve stood your ground in a bidding war, stretched your budget to the max and accomplished the Herculean feat of buying Toronto real estate. There’s just one problem – your lender won’t cough up enough dough for the whole mortgage. Suddenly, you’re scrambling to find the rest of the cash to close the deal – and stay out of legal hot water with the seller.

It’s a less-than-desirable situation but one that is becoming more common, say real estate agents; as Toronto home prices rapidly increase – up 27.7% from last year – lenders, insurers and appraisers aren’t always in agreeance with what buyers and agents feel a home is worth. Those with the minimum down payment of 5% down and trying to buy at the top of their budget are especially vulnerable; as homes once priced for the starter segment appreciate along with the rest of the market (condo prices are up 18.2% to an average of $515,424, according to TREB), they lack the financial wiggle room to counter should their mortgage come up short.

“Prices change so quickly that when appraisers are looking at the properties, they’re not as up-to-date on the market as we are,” says Carlos Moniz, an agent with Zoocasa Realty. “They might be pulling sales from two to three months ago, while we’re looking at sales from the same week.”

“People either need to have a whole bunch of cash to put down to get the financing, or if they’re putting down 5%, there’s no way it’s going to get appraised at what they paid. So if the bank appraises it at the $500,000, but we think it’s worth it’s worth $650,000, you need to come up with the additional $150,000, to make up for the $650,000.”

What Are Home Price Comparables?

These sales numbers are called home price comparables, and refer to the recent sold prices of similar properties – for example, the same-sized unit within a condo building, or houses on the same street. They’re vital data used in every home purchase and sale; agents refer to them when strategizing how much a home should be listed for, or how much a buyer should make in an initial offer.

They’re also used by the third-party appraisers that lenders and insurers rely on to determine the value of a home when granting a mortgage, as well as in the case of property refinances, renovations, splitting an estate, and assessing capital gains.

Prices Are Moving Faster Than Lenders Can Keep Up

While realtors’ access to comparables are practically in real time – necessary in Toronto’s hot housing market – lenders are using increasingly obsolete price data. In cases where less than 20% down has been made on a home purchase and mortgage default insurance is required, the info may be even more outdated.

“The appraisers do not have access to the near future closing prices, which the realtors do. Two weeks is a realistic timeframe for the properties sold and closed,” says Mike Bricknell, a mortgage broker at CanWise Financial.

“The service that the high-ratio insurers (CMHC, Genworth, Canada Guaranty) use tend to lag by a month or so, which could stop a deal in its tracks.”

Moniz adds that it’s especially challenging when such price jumps are without precedent and seemingly without justification.

He says that while there are three seasonal price upticks – January, spring and fall – this year’s surge has bypassed any typical trend, with comparables jumping by leaps and bounds. “I had a condo that we put an offer on, and all the comparable solds were in the mid-fours,” he says. “Because the market is really hot, I advised my clients, ‘We probably need to be in the high fours to be competitive,’ – this was in North York at Yonge and Finch, for a two-bedroom, two-bath listed at $399,000. We were pegging it at high 400’s based on the comparable sales over the past couple of months. It ended up selling for $615,000.”

Related Read: Was Your Down Payment a Good Investment?

Potential Legal Pitfalls

Aside from losing out on their dream home, failing to qualify for the full mortgage amount puts buyers in a legal bind if they’re in a firm offer to purchase – and as steep competition prompts fewer buyers to safeguard their offer with conditions, they must either come up with the cash, or potentially face a lawsuit.

“It’s so competitive that you can’t go in with conditions,” says Moniz. “You’re usually getting the home inspection from the seller, and if not, people are having to go in blind. It’s the same with the financing… Brokers and banks always tell their clients, ‘make sure you put a financing condition in’, but the reality is, they’ll never get a place.

“The scary part is people who are just barely able to get into the market. They may have 5% down, they were pre-approved for what they wanted and were going for the top of their budget… and now they’re scrambling to find financing and the mortgage broker is telling them, ‘You just need to come up with another $19,000.’ Well people don’t just have that under their mattress,” he adds. “If you don’t come from money or have family’s help you can lean to, you’re in trouble.”

How Buyers Can Protect Themselves in Toronto’s Hot Housing Market

Set Your Limit

In a market with so many affordability and financing barriers, what can buyers do to protect themselves from coming up short on their mortgage financing? Zoocasa agent Emma Pace says buyers must understand and be open about their financial limitations with their real estate team.

“We can guide you and give you our best advice on what it’s going to take to solidify this property, but ultimately, the due diligence is on the client to work with whoever is providing their financing to ensure they’re in the most comfortable position possible,” she says.

“If you can only go to x number of dollars, it’s important we stop at whatever that price point is, and either we adjust what we’re looking for in terms of criteria to get you into the market, or we need to stop at that price and hope that you can win at that price.”

Time is of the Essence

While waiting to gather a larger down payment may seem the financially prudent approach, Moniz warns that Toronto’s market activity is swiftly outpacing savings intentions.

“In a perfect world they should, but the difficulty you’ll run into is in the amount of time it takes for you to save that money, the market is outpacing that. I meet first-time buyers who say, ‘I have 10% or 15% down, but we’ll wait until we get to 20% to avoid CMHC.’ Well, the market is appreciating at 10 – 15%, and an average house is $500,000 – are you saving $50,000 after tax? Probably not, so you’re probably better off getting in, paying the CMHC and getting into the market earlier.”

Get a Second Opinion

Moniz adds that if time allows, buyers who aren’t happy with the mortgage amount they’re offered can try the tactic of switching lenders in the hopes of receiving a higher value appraisal on their home.

“What the majority of people do is go to a different lender (if they don’t like the appraiser result), and see a huge difference in valuation – it can be pretty subjective to the person,” he says. “But if they’re paying less than 20% down, they’ll have to go to a different insurer as well – and you only have three in Canada.”

Adjust Expectations

Pace says sometimes the solution is downsizing buyer expectations – even if it is a bitter pill to swallow. “If you need to make some adjustments, it’s better that you do so on what your criteria is, and sacrifice a bit on the unit and make sure you can actually get into the market, as opposed to overextending yourself if the appraisal doesn’t come back at the number you paid for, and get yourself into hot water,” she says.

About Penelope Graham

Penelope Graham is the Managing Editor at Zoocasa, and has over a decade of experience covering real estate, mortgage, and personal finance topics. Her commentary on the housing market is frequently featured on both national and local media outlets including BNN Bloomberg, CBC, The Toronto Star, National Post, and The Huffington Post. When not keeping an eye on Toronto's hot housing market, she can be found brunching in one of the city's many vibrant neighbourhoods, travelling abroad, or in the dance studio.

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