What is a Down Payment?

Definition of a Down Payment

A down payment is the initial amount of money paid, outside of financing, for the purchase of something.

Because most people can rarely afford to pay the entire purchase price for a large item such as a car or home, they will normally finance, or obtain a mortgage loan for most of the purchase price. The down payment is the amount of cash used by the buyer towards the purchase price.

Example

Mr. McGillicuddy wishes to purchase a home for $250,000, he has $25,000 in cash. Mr. McGillicuddy will use the $25,000 to pay for the home, leaving a $225,000 mortgage owing to the seller. Mr. McGillicuddy will then borrow $225,000, plus applicable mortgage insurance premiums , from a bank or financial institution. The $25,000 in cash that Mr. McGillicuddy used towards the purchase price is referred to as the down payment.

Effects of a Down Payment on the Buyer

In the example above, the buyer has $25,000 in equity in the property. The equity is the fair marker value of the property, minus the amount owed to the lender. The equity in the property remains an asset for the buyer on his or her financial statement.

Effects of a Down Payment on the Lender

The down payment not only provides equity for the buyer, it also provides a “cushion” for the lender, in the event the buyer defaults on the mortgage. With more equity in the property, the lender has more security in their increased ability to recover the money they loaned if default occurs.

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Sources of a Down Payment

Normally, the source of the down payment is cash from the borrower. Underother circumstances, the down payment may come from the following sources:

  • A down payment may be a gift from a family member, provided it is at arms length from the transaction;
  • Under limited circumstances a buyer may borrow the down payment from a financial institution;
  • A borrower who qualifies may borrow up to $25,000 from the borrower’s Registered Retirement Savings Plan (RRSP) for a down payment. Qualifications for borrowing a down payment under the Home Buyers Plan can be found here.

Down Payments and Homes in Canada

Down payments for housing purchases in Canada generally vary from 20% to as little as 5%. A purchase with a low down payment of 5% will require a high credit score, as well as mortgage insurance. On the other hand, a lower down payment may place a borrower in a home sooner than it would be if required to save a great deal of money for a larger down payment.

Your lender will need to determine not merely your equity in the property at the time the loan is given, but determine your ability to repay the loan, regardless of the equity. A large down payment may do no good if you are unable to make the monthly payments on the mortgage. If you have a good credit payment history and obtain a mortgage within your monthly budget, a low down payment may still be a possibility.

First Foundation will be happy to go over options with you regarding various down payments for different types of mortgages and determine which option is right for you!

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Last updated Oct 16, 2014