A Step Further than a Gifted Down Payment
When it comes to funding a mortgage, one obstacle that many people face is the down payment. Most banks and traditional lenders prefer applications with a down payment of at least 20 percent for the purchaser to avoid having to pay private mortgage insurance (PMI), which is basically coverage that pays the lender if the purchaser defaults on the loan. This can add tens of thousands of dollars to the cost of the loan if the purchase has to pay these premiums over the entire 20 to 30 years of the note.
In some other cases, a down payment of a certain size is the only way that a purchaser will get financing to buy a house. The bank has turned down the application, often as a result of a low credit score or failure to provide a verifiable income history, and so the purchaser has to find private mortgage financing if he wants to complete the purchase. Private mortgage financing often involves putting down as much as 25 or 30 percent of the purchase price (although it can be as low as 15 percent in some cases) in order to ensure that, if the lender has to foreclose on the house and sell it, he will still make money on the deal. Other more creative options may only require 10% down payment, and perhaps less with adequate collateral security.
This is where an Arm’s Length Mortgage comes in. This is an arrangement where a purchaser borrows some of the down payment from another party who is not related to him by marriage or blood. Many lenders still require the purchaser to provide a 10 percent down payment on his own, but the purchaser can arrange an arm’s-length transaction with another individual who will provide the remainder of the funds required to close as second mortgage. If the funder has enough funds, the lender can even provide a 1st mortgage to facilitate the complete transaction. The person doing the funding can use RRSP funds to provide the down payment to the purchaser — and the two parties frequently never even meet, as a broker facilitates the entire process.
Option 2 is the Mortgage Flex Down Payment. Very few lenders offer this option. With flex down mortgages, you borrow the money for your down payment from a third party — someone other than you and the bank extending you the mortgage. This could be a relative of yours, a friend of yours, a private third party, funds from a credit card advance, or a personal loan. The only requirement is that this party have no tie to the sale of the house — so it can’t be the seller who lends you the down payment and the bank can’t extend you a second loan to cover the down payment.
Another option… and commonly used is a Gifted Down Payment. This would be a gift that someone can provide to you at closing — generally a relative or a friend — that will augment your down payment to the point that the lender will be satisfied. These funds must be verifiable, and the purchaser must not be expected to repay the down payment to the relative (hence the word “gifted”).
A last option and rarely used is the Non-arm’s length mortgage. In this case, your friend or relative is still helping you by supplying you with the rest of the down payment, but in this case it’s still a loan. A person related to you by blood or marriage is providing you with RRSP funds or you are lending yourself some RRSP funds from your own account to make the down payment the right size. The difference between the two terms (arm’s-length and non-arm’s-length) has to do with the relationship between you and the person providing you with down payment assistance.
When it comes to RRSP funds, you can also fund an entire mortgage this way. However, there are some rules that you have to follow, whether it’s arm’s-length or non-arm’s-length. First, the RRSP(s) in question must have enough available cash to fund the entire mortgage as well as any other fees due at closing. The property has to be owner-occupied primary or vacation residence in Canada. The loan-to-value ratio can’t be higher than 90 percent (remember, the purchaser has to fund at least 10 percent of the purchase price independently). The term and rate of the mortgage must fall within 1 percent of a 1-5 year fixed rate that is taken from what Canadian Chartered banks offer. It’s possible to amortize the payment of the mortgage for up to 30 years. Payments must be pre-authorized from a bank account and combine principal and interest within each month.
It’s important to note that you’ll face the same legal and appraisal costs with this type of mortgage than you would with any other funding source. In some cases, mortgage insurance is a requirement, and the premium will vary depending on the amount of money you need to borrow and the type of financing in question. Insurers such as Canadian Western Trust typically charge an initial setup fee as well as an annual maintenance fee. This is the case when any mortgage down payment is less than 20 percent, and there is a renewal fee due when the term is up as well.
One benefit of funding your entire mortgage this way is that there is no penalty for prepayment. If you take out a closed mortgage through a bank or traditional lender, and you have enough money come in to allow you to pay the balance early, you end up paying a penalty based on the difference between what you would have paid to the bank if you hadn’t been able to pay early. You can take out an open mortgage, but the interest rates are higher in this case — because there’s the “risk” that the bank will get your money back sooner and take in less money as a result.
RRSP-funded mortgages are a great way for investors to boost their rate of return on their money as well. The interest available is higher than what you would expect to get from a government-secured fund — 9 to 18 percent in the case of second mortgages in many cases — but the risk still remains fairly low, because one of the last things that people will default on is the payment for their residence. So this can be a win-win on both ends of the transaction.
If your prospective home purchase and loan fall within these guidelines, then you have an excellent chance of finding an arm’s length mortgage or down payment funding source. If you already have a non-arm’s length relative or friend who is willing to make this investment with you, then the best time to get started is now — as interest rates are rock bottom and are only expected to rise over the coming months. Get in touch with one of our mortgage specialists at Amansad Financial, and we will discuss your situation and make recommendations as to potential arm’s-length funding sources and other elements of your mortgage.