Guest Writer: Peter Radonjic, Mortgage Specialist for our Coquitlam Real Estate Blog explains the new BC Government downpayment loan for first time home buyers.
As you may have heard, the BC government just announced the “B.C. Home Owner Mortgage and Equity Partnership program” which will lend first-time homebuyers up to 5% of the purchase price to use as a downpayment. For the first 5 years the loan is interest-free and re-payments don’t start until year 6. Here’s CBC’s article on it (NOTE the terrible headline – the loan is NOT “interest-free” it’s a loan with interest and payments – the clock just doesn’t start ticking on interest and payments don’t start for 5 years after you get the cash):
CBC: B.C. offers interest-free loans up to $37,500 to first-time homebuyers
Note this doesn’t let you borrow a full downpayment – you must have saved a down payment amount at least equal to the loan amount for which you applied. The Partnership Program will meet the buyer’s contribution up to 5% of the home’s purchase price. In effect at the minimum, you still need in cash 2.5% of the purchase price plus the existing CMHC rule of showing cash equal to 1.5% of the purchase price to prove you can afford to complete the transaction (i.e. pay for the closing costs).
A quick rule of thumb is you need cash equal to 4% of the purchase price – e.g. $20,000 to purchase a $500,000 property – in this case, $7,500 would be shown to CMHC to prove you can pay for closing coasts, the other $12,500 would go towards the downpayment, matched by a $12,500 loan from this Program.
This is an interesting swivel from the tightening of mortgage rules and warnings from federal government – even one from Bank of Canada the same day:
CBC: Bank of Canada warns about huge mortgages, growing housing debt
Is this “good” or “bad” for me?
Here’s my quick conclusion – if you are eligible for this program, then do it and do it as soon as possible! There are a lot of financial strategies possible here to take advantage of this program and it is possible the Province may cap the amount of applicants or end the program early. You can save/earn money in a few different ways:
- Reduce CMHC fees;
- Reduce interest that accrues on your mortgage (i.e. have a higher downpayment and a smaller mortgage amount);
- Use your money to invest to earn a higher return than the interest rate you are paying for your mortgage;
- Free-up the cash you were planning on using for the downpayment for other reasons: An emergency fund, paying down debts like credit card balances, lines of credit or car loans, purchasing life isnurance, or perhaps funding your RRSP, RESP, TFSA.
A Common Scenario
- $500,000 purchase
- $50,000 downpayment – $25,000 from the Program matching the buyer’s $25,000.
- $450,000 mortgage – and a resulting $2,200 monthly mortgage payment.
When the loan kicks in after 5 years, it’ll result in a monthly payment of about $140-160 (20-year amortization, with an interest rate set at Prime Rate+0.50%).
This means, assuming the mortgage payment stays the same, these first-time homebuyers will have to absorb an increase in their housing payments when this loan kicks in of 3-10%.
However, it makes sense from a financial planning perspective to use this program if you are eligible as essentially it’s a 5-year interest-free loan, especially if you already have at least 5% downpayment from your own funds. For example, take your own funds that are freed-up and invest them instead under the Tax-Free Savings Account to earn interest. At the five-year point, withdraw enough funds to pay off the loan and keep the difference. Typically, this would be better than just increasing your downpayment in this scenario.
Unfortunately you can’t use this extra 5% to add to a 15% or greater downpayment to get to 20% or higher down to avoid mandatory CMHC mortgage insurance as one of the requirements for this Program is to have mortgage loan insurance. However, a larger downpayment does reduce the CMHC fees (reduction occurs at 10% and 15%-down tiers). For example, for the same $450,000 mortgage, having a 10% downpayment instead of 5% means the CMHC fee is 2.4% of the purchase price not 3.6% – saving you $5,400.
Long-Term Outlook for Housing Prices in the Lower Mainland
In the Lower Mainland, with a maximum purchase price of $750,000 the vast majority of purchases will be strata properties like condos in Vancouver and townhouses in the suburbs. The chart below tracks the historical average prices – the red-line is townhouses and the green-line condos.
(As an aside, note the decoupling of detached housing prices from condos and townhouses – this effect is highly correlated to the population increase in Vancouver and thus value is driven by the land not the house on it. You can expect this decoupling to increase as population will continue to rise.)
As the price of detached houses will continue to grow at a higher pace than townhouses and condos, if your goal is to eventually own a detached home in your community of choice, your homeownership ladder plan should not be a VERTICAL ladder (own first a condo, sell and buy a townhouse, then sell and buy a detached house) but a HORIZONTAL ladder (buy detached house geographically farther out of the Lower Mainland, and work your way back towards the city moving from detached house to detached house).
From a broad perspective, the danger here is that these homebuyers can now purchase a property with almost no equity of their own – now funding the purchase with two loans – one from this program and the second the mortgage. This loan will go in 2nd position on the title. The federal government does not allow you to take a loan for a downpayment, and that this is somewhat similar to the way risky housing purchases were structured in the US that eventually sparked the sub-prime mortgage crisis.
The Fine Details from the BC HOME program website
Applications for the program will be accepted starting January 16, 2017. If you are already searching for a home, your application will only be considered if the closing date on the purchase of the home is on, or after, February 15, 2017. Other requirements of the Program are:
- Have been a Canadian citizen or permanent resident for at least five years
- Have resided in British Columbia for at least one year immediately preceding the date of application
- Be a first-time buyer who has not owned an interest in a residence anywhere in the world at any time
- Use the property as their principal residence for the first five years
- Purchase a home that has a purchase price price of $750,000 or less (excluding taxes and fees)
- Obtain a high-ratio insured first mortgage on the property for at least 80% of the purchase price
- Have a combined, gross household income of all individuals on title not exceeding $150,000
- Have saved a down payment amount at least equal to the loan amount for which the buyer applied
Information Needed to Apply
Buyers will need:
- Proof of status in Canada and residency in British Columbia
- Secondary identification (must include your photo)
- Proof of income and tax filings
- Insured first mortgage pre-approval
As always, your comments and messages are welcome and very much appreciated.
Peter
Peter Radonjic is a Certified Financial Planner, which helps him be a more effective Mortgage Specialist for Scotia Bank. The opinions and ideas reflected in this article are his only, and should not construe endorsement by Scotia Bank or any related affiliates. Please feel free to contact him at 604-789-8104