Some thoughts regarding Down Payment & Pre-Payment or Lump Sum payments;
Down Payment Amount
The first consideration; if one is able to achieve a 20% down payment this will avoid mortgage insurance premiums (CMHC, Genworth & Canada Guarantee). Thus 20% down is certainly a worth target as a baseline.
It is often worth pulling out all the stops to reach the 20% down payment amount. The savings of avoiding the Mortgage Insurance Premium can be significant, as well as having several additional opportunities with regard to mortgage products and lending guidelines once into the ‘conventional‘ mortgage space as opposed to the insured mortgage space.
The second consideration; if one finds themself unable to achieve a 20% down payment, then often sticking to a specific increment of either 5%, 10%, or 15% makes sense. The insurance premiums drop with each additional 5% down and hitting each milestone can again save a purchaser a significant amount of money.
The real question is when one has a down payment amount equal to something along the lines of 8%, 16%, 31%, 42%, etc. should they put that extra little bit down at all?
What is the real advantage to increasing your down payment beyond the minimum required to be most efficient and qualify for the mortgage requested?
The actual mathematics at this time are as follows;
Conventional mortgages (30 year amortization) each additional $10,000 of down payment lowers the monthly payment by $42.00
Insured mortgages (25 year amortization) each additional $10,000 of down payment lowers the monthly payment by $47.00
Often when clients are talking about putting an additional $5,000-$10,000 down over and above one of the key 5% increments I ask them to pause and think about whether such a small difference in the monthly payment ($21.00 to $47.00) is worth reducing their own liquidity (.i.e. nest egg). With long-term GIC’s available at similar interest rates as the actual mortgage interest rates today it is perhaps prudent to park that $5,000 or $10,000 in a secure investment where can be easily (but not too easily) accessed in the event of a genuine emergency. As opposed to putting it down on the property where accessing it can be difficult at best, if not outright impossible.
Lump Sum Payments;
Much the same thinking applies when talking about making lump sum prepayments to existing mortgage balances.
Of course being mortgage free is the Canadian dream, but we have to be aware of some key realities at this time.
With record low interest rates the actual savings is negligible, and with ever tightening lending guidelines accessing that capital back out of the property should the need arise can be. As mentioned above, extremely difficult if not impossible.
A key consideration would be whether or not there is a chance that one may need the cash back in hand in the next year or two for one reason or another. If this is a possibility and the mortgage is set up as a home equity line of credit type product, also known as a re-advanceable mortgage, then you have a safety net – a way to access the capital again in the future should you need it. This takes away one risk.
However if it is a standard mortgage product with no line of credit currently behind it then depending upon the circumstances under which one qualified for their mortgage originally, the current point in the mortgage term, the current value of the property, the percent of property value the current mortgage represents, …and a whole host of other variables that may not even be on ones mind at all – one must consider any pre-payments made to the mortgage as a one-way valve. In other words you can put that money on to your mortgage, but you may not be able to re-access it – short of actually selling the property.
This is a very real concern as lending guidelines have changed radically over the past four years, in particular if you are a self-employed individual.
Another Key consideration is whether or not this is truly the highest and best use of said capital. If you, as so many thousands of other Canadians, are currently enjoying a sub 3% interest rate you must pause and ask yourself if there is anywhere that you can park that money where it might earn an equivalent or greater interest rate and yet still give you the benefit of liquidity in the future should you need it.
After all if you can park that money in a conservative investment vehicle earning 4% or better than why not let it sit there and keep your options open. When the time comes that interest rates do start to rise, if your investment returns do not rise as well then you can cash out said investments and reduce your mortgage debt at that time.
I like the idea of being mortgage free sooner, and with accelerated (and slightly inflated) payments this will happen. However when it comes to significant lump sum payments at this point in time I think there are better options than paying down 2.15% debt.
Thank you for your time.