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Down Payment

Can Home Equity be Used as Down Payment?

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It is acceptable to borrow money to cover a down payment if you contribute a portion of the down payment with the cash you already have. The guidelines for where you can get your down payment are uncomplicated. You must contribute a minimum sum from your funds to the lender, equaling 5% of the purchase price up to $500,000 and 10% of the buying price over $500,000.

There is no restriction on using a home equity line of credit (HELOC) for a down payment. Any loan backed by an asset, such as a mortgage, an RRSP, or a life insurance policy, will function. HELOCs, however, can be challenging for first-time homeowners because you need to have a minimum of 20% equity in your house to qualify for one.

Some lenders only allow the use of further resources, such as an unsecured line of credit, after the minimum has been satisfied. That is to say, after you have saved up the minimum down payment, you might be able to borrow money from other sources to raise your down payment. However, if you are close to the maximum amount you can afford, carrying debt may make your purchase price unaffordable.

The good news is that most Canadians use their savings as their primary source of down payment cash, including assets held in RRSPs and TFSAs. So, is borrowing money for a down payment a wise idea? Let’s examine the benefits and drawbacks.

The benefits of taking out a loan to pay for a down payment on a house

A loan to cover your down payment is not necessarily a terrible option. In fact, under the appropriate circumstances, it can save you hundreds of dollars! Here are a few of the benefits.

1. Enter the market more quickly

This is the most alluring justification for taking out a loan for a down payment. Borrowing may be able to help you purchase the home you want to give today’s exorbitantly high housing costs.

2. Quit squandering money on rent

Renting a property is not always a negative financial choice, but your monthly rent check is guaranteed to disappear forever. If the value of your property doesn’t decrease, every dollar you pay in principal (the component of your mortgage that pays off the loan) is a dollar you get to keep in the form of equity. In fact, rent payments and mortgage interest might be viewed as “wasted” money. Determine how much you can afford on a home before searching for a mortgage to prevent paying extra interest.

3. Increase your wealth

The housing lottery was won by many people who purchased homes in the previous ten years as prices rose quickly. In consequence, this helped household net worths rise quickly. Home prices are still up about 3.5% from last year despite recent indications of a weakening property market. Given the recent past, entering the home market earlier could aid your long-term wealth accumulation.

4. Save on mortgage default insurance

When you purchase a house with less than 20% down, you must pay mortgage default insurance (often called CMHC). The premium you pay depends on the size of your down payment – rates drop as you pass the 10%, 15%, and 20% marks. Bryan Freeman, Chief Operating Officer of Ratehub.ca, says that borrowing for a down payment makes sense in some situations. For example, a secured loan source like a HELOC can increase your down payment and save thousands on CMHC insurance, lowering your monthly payments.

Cons of taking out a loan to pay a down payment on a house

Borrowing against your down payment carries dangers, just like any other financial transaction. Before you decide, be sure to take these factors into account.

1. Repayments may be expensive

If you’re borrowing from a financial institution, your down payment loan will probably have a significantly higher interest rate than your mortgage. The interest rate on your mortgage could be much higher than it would be on a typical 5-year fixed mortgage if you choose a cash-back mortgage to pay for your down payment. In this scenario, the whole balance of your mortgage will be subject to an increased rate.

2. Fewer equity increases risk

Your protection against unforeseen events like unforeseen repairs or an abrupt job loss is reduced by additional monthly loan payments. There may be fewer options available if you can’t pay your expenses with savings because you usually need at least 20% equity in your home to be authorised for a home equity line of credit (HELOC). You can also discover that you owe more money on your home than it is worth if house values decline, which is increasingly likely.

3. More debt makes things less affordable

Lenders will assess your mortgage affordability when you apply for a mortgage, among other things, by looking at your debt service ratio. Your housing expenses and other debts are represented by this portion of your income. Your debt service ratio will be affected if you take out a loan to pay your down payment. Your ability to borrow money for a mortgage may be affected by the cost of paying back your borrowed down payment.

4. Other issues can arise when borrowing money from family

About 30% of first-time homebuyers in 2021 received assistance from the “Bank of Mom and Dad.” However, stealing money from family members can result in further issues. Varied family politics have different outcomes, but conflict over money is a frequent source of conflict. Additionally, disagreements over costs like furniture or décor can damage relationships and make it harder to appreciate your new home.

Can I get a loan for a down payment on a house?

A deposit, which should not be confused with a down payment, is the sum of money you provide the sellers when you make an offer to purchase their house. You and the seller can agree on the deposit’s amount, and you are free to take out a loan to pay for it.

With that said, your deposit counts toward your down payment. You’ll still need to demonstrate your ability to pay back the money you borrowed for the deposit before the transaction closes or furnish the bare minimum from your current assets.

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