You’ve scrimped and saved enough for the minimum 5% down payment on your first home – congratulations! As you’re getting ready to pop open the champagne, a thought crosses your mind: should I buy now or should I save a larger down payment?
The size of your down payment is important when shopping for a home – not only does it determine your purchase price and monthly budget, it can save you thousands on interest. Homebuyers are also faced with the decision of whether or not they want to save enough to avoid mortgage default insurance, which applies to purchases with less than 20% down.
We’re here to explain the differences between saving for a larger down payment and just buying with the amount you have saved now.
Saving a Larger Down Payment
If you’re able to sock away extra money each month, and save for a larger down payment within a couple years, it’s worth considering. Not only will it reduce your monthly principal and interest payment, putting more money down will save you thousands in interest over the life of your mortgage.
If you have at least a 20% down payment, you’ll also qualify for a conventional mortgage and avoid costly mortgage default insurance. A sizable down payment is also likely to attract lower interest rates from lenders, since it puts you at a lower default risk.
If all you can only afford is a shoebox one-bedroom condo and you’d rather own a detached house, saving a larger down payment is a good first step. A larger down payment also provides a buffer, if a housing correction ever occurs.
For example, if your house is currently valued at $950,000 and a 15% housing correction were to occur, your house would only be worth $807,500. With a down payment of $190,000 (20%), you’d still have $47,500 equity remaining ($807,500 – $760,000 = $47,000). However, if you only made a 5% down payment of $47,500, your mortgage would be underwater by $95,000 ($807,500 – $902,500 = -$95,000).
Although it may sound like a good idea to save a larger down payment, it doesn’t always work for everyone. Start by examining your monthly budget. How much can you save a month and how long will it take you to reach your new savings goal? For example, if you can save an extra $500 a month that’s $6,000 a year you can put towards your down payment.
In higher-priced markets like Toronto and Vancouver, being priced out of the market (when house prices rise faster than your down payment) is a real concern. For example, if you’re pre-qualified for a $950,000 house and house prices rise 10% next year, you’ll have to save at least $95,000 to be able to afford the same house. Can you really manage that?
Saving a larger down payment requires financial discipline – are you really willing to cut back on those daily trips to Starbucks and annual vacations to Mexico? But buying now makes sense if your lender has decent prepayment privileges – you can always make lump sum payments or increase your mortgage payments, if you get a raise at work or come into some money.
Want to see what you can qualify for? Check out Zoocasa’s mortgage calculator to estimate monthly costs and view the lowest interest rates available from lenders.
About the Contributor
RateHub.ca is an independent, impartial website that compares mortgage rates. RateHub also focuses on delivering clear, easy-to-understand mortgage education and robust mortgage calculators.
Published: December 19, 2012
Last updated: January 25, 2023