Many people rely on banks in order to borrow money to purchase their house or condo. Over the last two decades, interest rates have been at historical lows and homeowners are not intimidated by the ever increasing price tags of houses, especially in larger city centers. Some economists would argue that if interest rates increased substantially, many homeowners would have to sell their properties which would create much pressure on the overall housing market being reflected on reduced prices. This is one of the reasons for a larger down payment strategy. If you have less than 20% of the purchase price as a down payment you have to purchase default insurance from CMHC (Canada Mortgage and Housing Corporation), which can cost up to 3.6% of the mortgage amount. On a $200,000 mortgage, this represents a one-time premium of $7,200.
Some bankers or mortgage brokers often recommend that their clients choose a five year or longer term for their mortgages. My personal preference is to select a much shorter term, six months to one year. If you ever decide to work with a different financial institution you would avoid penalties to brake the term of your mortgage. The other argument made for a longer term is; what if interest rates go up? Well the “what if” scenario has not been a factor in the last 10 years. In fact, studies have shown that those who have subscribed to short term rates have paid less interest.
By establishing a 20% down payment you benefit from structuring an interest only portion of your mortgage. This will reduce your monthly payments allowing you to redirect this money to create new tax savings.
What’s next? Tax free savings in life insurance contracts.