Acceptable Down Payment Sources in Canada
Introduction
A down payment represents the upfront portion of the total cost of a property that you pay out of your pocket. In Canada, the minimum down payment required can range from 5% to 20% of the property’s purchase price, depending on various factors such as the property’s value and whether the mortgage is insured. But where can this money come from? What are the acceptable sources for this significant financial commitment?
In this article, we will go into detail about the various sources that are considered acceptable for down payments in Canada. From savings and investments to borrowed funds, we’ll cover all the options you have at your disposal.
Traditional Down Payment Sources
These are the most common sources of down payments:
- Savings and investments as a source of down payment.
- Sale of Property.
- Using Registered Retirement Savings Plans (RRSPs) as part of the Home Buyers’ Plan (HBP).
- Gifted funds.
Savings and Investments
Savings and investments form the backbone of traditional down payment sources. These funds are typically accumulated over time through disciplined saving and wise investment strategies. Savings accounts, Guaranteed Investment Certificates (GICs), mutual funds, stocks, and bonds are all potential sources of down payment funds. It’s important to note that while investments can significantly boost your down payment funds, they also come with risks. The value of investments can fluctuate with market conditions, and there’s always the possibility of losing the principal amount invested. Therefore, it’s important to have a diversified investment portfolio and to consult with a financial advisor when planning to use investments for a down payment.
Sales Proceeds from Another Property
For homeowners who are selling their current home to purchase a new one, the equity built up in their existing property can serve as a substantial source of down payment for the new home. The sales proceeds from the property, after paying off any outstanding mortgage and related selling costs, can be used directly towards the down payment on the new property. However, it’s important to consider the timing of the sale and the purchase, as any delay could impact the availability of funds for the down payment. So plan this carefully to avoid any potential financial pitfalls.
Registered Retirement Savings Plans (RRSPs)
In Canada, the government has established the Home Buyers’ Plan (HBP) to assist first-time homebuyers. This program allows individuals to withdraw up to $35,000 from their RRSPs to use as a down payment on their first home. Couples can withdraw up to $70,000 combined. This is a significant benefit as the withdrawn amount is not taxed as income, as long as it’s repaid within a 15-year period. However, it’s crucial to understand the repayment rules to avoid any tax penalties. It’s also worth noting that using RRSPs for a down payment should be carefully considered as it could impact your retirement savings.
Gifted Funds
Gifted funds from family members are another common source of down payment. Many parents or relatives are willing to provide a financial gift to help loved ones secure a home. It’s important to note that lenders usually require a gift letter confirming that the funds are indeed a gift and not a loan.
Non-Traditional Down Payment Sources
These are some of the non-traditional sources of down payment:
- Borrowed funds as a down payment.
- Rent-to-own schemes.
- Lender cashback incentives.
- Divorce Settlement.
- Inheritance or other windfalls.
- Sale of Vehicle or Other Asset.
Borrowed Funds
While not typically the first choice for many, borrowed funds can serve as a down payment source. This could be from a personal loan or a line of credit. However, it’s important to remember that borrowed funds increase the borrower’s debt load and may impact their debt service ratios, a key factor that lenders consider when approving a mortgage. Borrowed funds should be considered as a last resort, as they increase the overall debt burden and could potentially lead to financial strain if not managed properly.
Rent-to-Own Schemes
Rent-to-own schemes are an alternative path to homeownership for those who can afford monthly rental payments but struggle to save for a down payment. In these arrangements, a portion of the rent paid towards a property is set aside for a future down payment. While this can be a viable option for those who struggle to save, it’s vital to understand the terms of the agreement, including the purchase price of the home and the rent premium. These schemes often involve complex contracts and potential buyers should seek legal advice before entering into such agreements.
Lender Cashback Incentives
Some lenders offer cashback incentives that can be given to the home buyers on closing. Technically the buyers still need to have the down payment available on the closing day, so we can’t really classify them as a down payment, but more like partial rebate of the down payment on closing. While this can help reduce the upfront costs of buying a home, these incentives often come with higher interest rates and may result in higher costs over the life of the mortgage. It’s important to carefully consider the long-term implications of such incentives.
Divorce Settlements
In some cases, existing property equity can be used as a down payment when there is a marriage breakdown and one spouse is buying out the other. However, it’s important to consult with a legal professional to understand any potential legal implications. Divorce settlements can be complex and may involve various legal and financial considerations.
Inheritance or Other Windfalls
Inherited funds or other windfalls can also be used towards a down payment. It’s crucial to consider any potential tax implications and to manage these funds wisely. Inheritance can be a significant financial windfall, but it’s important to use these funds responsibly and consider the potential impact on your overall financial plan.
Sale of Vehicle or Other Assets
The proceeds from the sale of a vehicle or other valuable asset can be used as a down payment. This can be a practical option for those who own assets that they no longer need or use. However, it’s important to consider the potential tax implications of selling assets. As such, it’s always recommended to seek professional advice when going through this process.
Conclusion
Please note that this is not an all-inclusive list, and there may be other sources of down payment available. While each of these sources can provide funds for a down payment, it’s important for potential homeowners to balance their use. Relying too heavily on one source could have financial implications. For example, withdrawing too much from an RRSP could jeopardize retirement savings, while relying too heavily on investments could expose the homeowner to market risks. Therefore, it’s crucial to have a diversified approach when accumulating funds for a down payment.
When deciding for a down payment amount to use, it’s also important to consider other home buying costs such as closing costs, moving expenses, and home repairs or upgrades. Having a fund for these unexpected expenses can help ensure that you can afford your new home without financial stress.
Remember, while a larger down payment can reduce your mortgage payments, it’s important not to deplete your savings entirely. Always maintain an emergency fund and consider your other financial goals, such as retirement and education savings.
About Us
At TheBroker.ca Ltd, we understand the importance of down payments, and what constitutes an acceptable or illegal down payment. Don’t jeopardize your home purchase by making a mistake with your down payment. Talk to us. We can offer you helpful advice on getting a mortgage, the current mortgage rates, and guide you through the process that will help you make informed decisions that align with your financial goals.
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Disclaimer: Please note that this information is current as of the date of publication and is intended to be general in nature. It is not intended to provide legal, tax, financial, or other professional advice and should not be relied upon as such. Always consult with a professional for advice tailored to your individual circumstances.
