Recently a friend of mine started a new career as a realtor. She e-mailed me asking for my opinion with respect to purchasers buying with little or no down payment. After I finished my e-mail, I thought it might be worth sharing a few of the highlights on this blog.
There are options available for buyers who can’t produce a large down payment. Several institutional lenders offer Cash-Back mortgage options, however these require the potential borrower to evidence their ability to finance a 5% down payment from their own resources, plus cover any closing costs (which average 1.5% of the actual). Also, lenders will be looking for borrowers with strong credit history, debt serviceability, and job stability, to offset the risk of the smaller down payment. Mortgage insurance may be required, and the insurer can request an appraisal to confirm the accuracy of the market value of the property, which will add a few days to the approval process. (It is also worth noting that institutional lenders will generally lend to the LOWER of the appraised value or the purchase price.)
Another option – and one I’m a fan of – is the RRSP home buyers withdrawal plan. For buyers looking to fund a down payment, this is quite simply one of the best options available to them. If parents will be involved in funding the purchase, it might be prudent to consider participating in matching contributions to their child’s RRSP. This can make the actual process of the gift less painful when the time comes for the actual purchase. The ability to withdraw from these tax-sheltered RRSP funds will be an asset in making a mortgage deal work, and should be a cornerstone of any first-time buyers planning process. (An RRSP which has been systematically accumulating over a period of time can influence a lender’s view of your credit risk and ability, demonstrating good established saving habits.)
If a borrower decides to apply for conventional financing (for a maximum of 80% loan-to-value on a purchase) with the intent of adding secondary vendor take back financing, the lender will require a minimum of 10 – 15% real equity from the borrower. (Historically, default rates are lower when a borrower’s equity is real money saved from individual resources.) During the approval process, the lender will include this anticipated second mortgage in the calculation of both the borrower’s ‘Shelter Costs’ and Gross Debt Service Ratio.
The bottom line is that there are some creative institutional lenders who offer specialized mortgage products for borrowers who don’t have large down payments. However, the interest rates on these products are higher than market on a prime plus basis, there is normally a small fee to the lender, and the restrictions are greater. Lenders with these products are looking for borrowers who – due to lower credit scores and debt serviceability – don’t fall within the bounds of conventional borrowing, but will likely do so by the time their proposed mortgage matures. It should be of no surprise that these products are priced to make additional profit for the lender to compensate for the potentially higher default rate and increased administrative costs.
A note about vendor take back mortgages: because the lender in this situation is, in fact, the seller, it is important to note that they assume a high level of risk. A great deal of care must be taken to fully disclose the risk – I’m not saying that every borrower is bad, but things can and sometimes do go wrong. Clients need to be made aware of these potential risks. There is risk for the buyer, too. There are no guarantees when it comes to refinancing, and neither are they assured that the vendor will still hold the interest in their property – it may have been sold off to fund a Mediterranean cruise, and there are no guarantees that the new mortgagee will be cooperative.
We love it when one size fits all, but I find that when it comes to mortgages, every deal is different. There’s my $0.02 worth, hope it helps.
Paul E. Croy