What is a down payment?
Most Canadians don’t have enough money to pay for a home with cash they have in the bank. Instead, they apply for a mortgage, and they start with a down payment. The cash payment that the buyer makes toward the property is the down payment – the difference between the agreed purchase price and the mortgage loan. If you purchase a house for $500,000 and you have 20% saved for the purchase, Your down payment would be $100,000 for a $400,000. Down payment does not include closing costs.
Down payments can come from different sources. Some borrowers have saved a down payment, but other borrowers receive gifts from family members, friends or others that they use as a down payment. It is even possible to borrow a down payment in some cases. Each lender has its own guidelines and rules as far as the source of a down payment.
Where do borrowers typically get down payment assistance?
There are several sources that borrowers use to make a down payment:
- Savings accounts. If you save up a down payment, the lender will want to see that you have had that savings for at least 90 days. This keeps borrowers from masking gifts, loans and other sources as their own savings.
- Gifts. In Canada, you can use gifts from immediate family members as your down payment, so long as the lender can verify the sourcing and that you do not have to pay the down payment back. You do not have to have the money in your account until closing. Some lender-specified programs have exceptions, so you will want to clarify this with your loan officer.
- First-time Home Buyer Down Payment. This is an incentive program from the Canadian government to assist people with their first home purchase, to help them move from renting to home ownership without adding significantly to their financial obligations. Participants do have to meet the minimum insured mortgage down payment requirements in order to take part. At this writing, so long as your qualified annual income is no more than $120,000, the government will assist with 5 to 10 percent of your purchase of a newly built home, 5 percent of your purchase of an existing home, or 5 percent of the purchase of a new or existing manufactured or mobile home. The combination of the insured mortgage and incentive amount cannot total more than four times your qualified annual income.
- Government Grant and Assistance Programs. Helping Canadians move from renting to home ownership is a priority for the government, and so there are quite a few assistance programs designed to help people get into a mortgage. In addition to the First-time Home Buyer Down Payment, there are several other programs. The Home Buyers’ Amount provides a $5,000, nonrefundable, income tax credit for a qualifying home purchased during the tax year. That credit could provide as much as $750 in federal tax relief. The Home Buyers’ Plan lets borrowers take as much as $35,000 within one calendar year from a registered retirement savings plan (RRSP) to purchase or build a qualifying home for yourself or a relative who has a disability. The GST/HST New Housing Rebate can refund some of the GST or HST that you paid out for the purchase price or construction cost for your new home. This can also apply for significant renovations or additions on an existing home, or for the cost of converting a non-residential structure into a home. Canada Greener Homes provides a variety of loans and grants for the purpose of improving energy efficiency in the form of retrofits.
- Sweat Equity. What’s this? Read on.
So just what is sweat equity?
Any time you can increase the value in a property through labor performed toward restoration or upkeep, then you have added “sweat equity” to the value of the property. This does not come in the form of cash but instead takes the form of time, mental effort and physical labor. The term originally referred to the work that people did to add value to their home through their own physical work. In our own time, technological advances of construction mean that having your neighbors over to raise a barn (or, in a more modern or urban setting, perhaps a shed).
In a modern setting, though, “sweat equity” means something somewhat different. Investors who flip homes for profit can put sweat equity to work for them by completing repairs and renovations before they get that house on the market. The more savvy an investor is at carrying out these types of projects, the more money s/he can save over time.
How can I use sweat equity to overcome down payment hurdles?
Let’s say that you have some savings in the bank, but you don’t have the 20 percent that you would need to avoid paying private mortgage insurance (PMI) premiums, and you have not yet qualified with a conventional lender for purchase and improvement. Also, let’s say that you have some experience in your background with construction and/or renovations, and you have a connection with one or more of the well-priced trades and understand how to complete projects with quality. What you can do is approach the situation as a sort of “renovation flip.” Here are the steps to take:
- Scout out properties that need work but that can shoot up in real estate value after some low cost renovations. To make your decision easier, ask for a “Current” & “As If Renovated Value” on the property. This will give you a sense of whether the renovations you would like to make will get the property value where you want to get it. If you are working with a realtor, request for a CMA (Comparative Market Analysis) before the appraisal.
- Once you’ve found the right property, sign an Agreement to Purchase, but get an extended closing date. Twelve months down the road is a good date, if you are confident that you can get all of the renovations finished during that time frame. You may need to put down a security deposit, or you might need to rent out the property while the renovation is taking place in order to keep the bank happy.
- At purchase time, secure an updated property appraisal to confirm the new value after the improvements.
- If there is any question about approval through a conventional lender, secure a private loan in order to finish the purchase. A private loan comes through an individual or entity looking to invest in real estate but does not come with the regulatory hurdles of conventional mortgages in Canada.
- Complete the purchase, and then prepare to refinance with a conventional lender within six to twelve months. The elevation in value thanks to your renovation should play a significant role in your application, and assuming that nothing negative has hit your credit during the interim, your application should move smoothly.
Here’s an example: let’s say that you agreed to purchase that home for $500,000. You make renovations that cost $75,000, and then the appraised value comes back at $725,000. Let’s say that the property is a single family home within an urban centre, you could expect financing to cover 75 percent of the purchase price, but that would be based on the new value. That means you could request up to $543,250 in financing. Given all of this, you could get the sweat equity credit from a private lender.
It is important to note that you would have to have permission from the seller to work on the house before closing; this is why you ask for the extended closing period. This is obviously going to work more in urban areas. Generally, the owner of the property either does not have the means or the interest to take care of the improvements himself or herself. This is an opportunity for you to move in and either flip the house at a profit or move into an up-and-coming neighborhood without having to make a cash down payment.
Given the way that the residential real estate market is moving right now, particularly in Southern Ontario, the BC Coast and other metropolitan areas in Canada, there is a lot of upward movement in value. A lot of owners of properties, even somewhat distressed ones, are taking advantage of this increase, even without making repairs beforehand. There is still plenty of room, though, in the market for people who have the necessary skills to come in and take these properties over, making several times their investment in terms of materials when it comes time to flip the property. If you have been waiting to make the jump from renting to owning your home, this could be the perfect time to give your family that sense of security.
Amansad Financial has been able to assist home buyers with the use of “sweat equity” to get into a house with minimal down payment. Get in touch with us today. We will answer your questions and come up with suggestions that are specific to your financial situation.