Looking to buy a Home with No Money or Zero Down payment
Well, I’m sorry to disappoint you, but the options of buying a home with either “no money down” or “zero down payment” are no longer available!
Escalating home prices, a slow economy, and low interest rates have resulted in the rules getting tightened in the last few years. Our government has been increasingly concerned about the high debt level of Canadians and they have instituted measures to try and make sure people don’t get over their heads financially. Some of the changes include:
- Elimination of no down payment when buying a home – the rule is that a minimum of 5% of purchase price is needed. (you will require 5% of the first $500,000 and then 10% of the balance for anything above $500,001.)
- Bringing the amortization period back to a maximum of 25 years from the previously allowed 30 years, and sometimes more. (Translated, that means how long it will take you to pay off your mortgage.)
- Increasing the premium charged for mortgage insurance, which is required if your down payment is less than 20% of the purchase price. (In fact, the premiums have been increased three times in the last four years.)
- Introduction of a stress test such that even if you get a very low mortgage interest rate, your ability to meet your payments will be tested at a higher rate – as of January 2017 this was 4.64%.
So, what are the minimum requirements for me to buy a home?
This is the real issue, and here they are if you apply for conventional bank financing:
- Minimum down payment of 5% of home purchase price.
- A credit score of at least 680, meaning you are a good risk.
- Mortgage insurance will be required, and this will cost a percentage of the amount of the mortgage, depending on your down payment – for example after March 17, 2017 with a 5% down payment the CMHC mortgage insurance premium (which can be added to your mortgage) will be 4.5% and increase from 3.85%. (refer to CMHC site to learn more)
- Income such that your ability to cover your housing costs will be either 32% for GDS and 40% for TDS (details on what this means is shown below).
There are lenders, other than banks, who can deviate from these minimums. Typically, this will mean the following:
- Potentially higher interest rates.
- A higher down payment, particularly if your credit score is low.
- Possibly more leeway on payment ability e.g. GDS of 34% and TDS of 42%.
Discouraged? Don’t be, for every challenge, there is a solution! (The writer is a principal in a company that provides such solutions.)
What can I do if I am only short on the minimum down payment?
Well, you may be in the best shape of all. There are a number of solutions. First off, let me suggest that you first determine how much you can afford to pay for your home. This will help you zero in on how much your down payment will need to be, and how much of a gap needs to be filled.
There is a simple rule of thumb – take your annual income and multiply it by 3.5. For example, if you earn $80,000 per year, you should be able to afford a home costing $280,000. You might say “there’s no way I can find the type and size of home we need for that amount!” – you may be right. So, if you are financially disciplined and have learned how to manage your money, you could use a factor of 4.0, that would give you a value of $320,000. Avoid being tempted to use a higher factor, you will only end up being disappointed when the lender won’t approve you for 95% of the $400,000 home you dream about!
Okay, so now reality has set in, you know what you can afford; therefore you can calculate how much you are going to need. So let’s use our $320,000 home price as our base.
$320,000 multiplied by 5% =$16,000.
You say to yourself, that’s not so bad! BUT, there will be other costs – you have to consider there will be a property transfer tax, and there will be legal fees, disbursements, and don’t overlook a home inspection. A quick way to estimate that amount is to add another 2% of the purchase price – in our example this would be an additional $6,400. (There will likely also be moving expenses, and a few other things like new blinds, perhaps some appliances, etc., to consider.)
So now we need at least $22,400.
So now the question is: “How much do I have?”, followed by “How much more will I need? – only you can answer that!
Here are some options that you can consider to fill the gap:
- Do I have any assets that I can tap? For example, a first-time home buyer with an RRSP can borrow up to $25,000 from it – but it has to be repaid within 15 years. (First time home buyers also get a break on the land transfer tax in Ontario and receive a tax credit.)
- What about other assets? If I have a TFSA, I can take funds from there without a penalty, and I can start replacing them in the following year.
- Could I use my line of credit? That works, but you need to consider that, at minimum, interest has to be paid monthly, plus the interest. (There is also the possibility that this could impact your debt payment ratio.)
- Are there any assets that I can sell to raise money? Maybe some of the extras like a boat, or an extra vehicle that I could do without and don’t mean as much to me as being in my own place.
- Do I have family who would be prepared to gift me the funds towards the down payment? (A gift letter is signed acknowledging the funds do not have to be repaid, but you still need to have enough funds saved for the closing costs)
- Government and municipal grants that may be offered as incentives to First-time Homebuyers (There may a program available to you under the Canada Affordable Housing Program or Government of Canada to assist low to moderate income earners)
- How long might it take me to save the additional amount I need, and can I wait that long before getting into my own home?
These are the main options, but we may be able to come up with other ways.
One solution you could consider might be going the “rent-to-own” route. There are variations of this approach – however, you need to be cautious; not every program will necessarily meet your specific needs. (I suggest you read our article on red flags and what to know about RTO for before entering into a rent-to-own program.)
What if my issue is not money, just a low credit score?
This is a bit more of a problem! It usually means that conventional mortgage lenders will not approve your application – they don’t like to take a chance on people whose payment history is not great.
The most obvious solution is to find a second-tier lender willing to take a chance on you and approve a mortgage. There will be implications, which are summarized below:
- The down payment will likely be around 15%, not 5%.
- Mortgage insurance will still be required if down payment is less than 20%.
- The mortgage interest will likely be 3% more than what a bank might offer for the same term.
- There may be additional fees, such as 1% or 2% or the mortgage amount that is added to what you actually receive, or you may have to pay the lender’s legal fees.
Providing you have the funds – using our example from above of a $320,000 home, you will now need perhaps as much $48,000 in down payment, and at least another $6,400 in closing costs.
Then your interest could cause your monthly payments to be not significantly different than they might have been with a lower down payment and lower interest, had you been able to qualify for conventional financing.
So what might you do? Now the options are a little more limited:
- Perhaps you could get someone to be your guarantor for a conventional loan; banks can be quite comfortable with this so long as they are certain they will get paid back – if you don’t pay, your guarantor will have to!
- Alternatively you may have parents willing to co-sign for your mortgage. If both you and your co-signor can get on title and on mortgage, when your credit has improved, you will likely be able to get your own mortgage renewal and assume full title. This may also avoid potential double transfer taxes and reduce legal fees when you assume title and mortgage on your own. (not all first time homeowner incentives/programs are available if the consignor currently owns a home)
- The other option is the rent-to-own program mentioned above. Having additional funds will make it more likely that you can negotiate a better overall deal, getting you into a home sooner, and getting on title when you qualify for conventional financing. It will be more costly for you than the previous option, but it may meet your housing needs.
If credit is your issue, make sure you get credit counselling and set up a plan to repair your credit as quickly as possible.
What if I have a low credit score and not enough for a down payment?
There is no doubt this is tough situation to find yourself. The first solution is that you remain a renter until you have either accumulated the funds required by a second tier lender, or until you have fixed your credit.
The options for getting into your own home have all been identified in the previous sections.
- You will still need to have a minimum amount for a down payment – if your credit score is fixable, and you have decent income and job stability, some home purchase solution providers will accept you with a 3% down payment.
- Your credit score should be repairable within a minimum of 4 years, and you should seek credit counselling – these counsellors, who generally work for non-profit organizations, can frequently suggest very workable solutions.
- Carefully select a reputable provider of a home purchase solution that will tailor something that meets your situation.
Our Home Purchase Solutions program may be the option you need!
The major mortgage lenders (read: banks) are regulated and they use three key measures to determine if you qualify for a mortgage:
- Your credit score – usually a minimum of 680 (more about that later).
- Housing cost as a percentage of your income – usually 32% of Gross Debt Service (housing cost = mortgage principal and interest payments + property taxes + heating costs as a percentage of your income).
- Total Debt Service – usually 40% of your income to cover your housing costs plus other obligations such as car loans, and other major debts.