How Much Money Should You Put Towards a Down Payment of a Rental Property?

Tyler

6 years ago

How Much Money Should You Put Towards a Down Payment of a Rental Property? When it comes to down payments there is no definitive answer on how much you should pay. How many properties you own, your current financial situation, and how close you are to retirement all have an impact on what decision you might make. In this post we will be looking at 3 different downpayment options, their pros and cons, and what we would recommend to you.

1. 20% Down Payment

This is the most popular downpayment option that many people choose when they are buying a home, as it is the minimum that you can put down without being considered a high-ratio mortgage. In fact, it is so common, that many new homeowners do not even realize that they can put down a percentage more or less than 20%. Although 20% is the standard, is it actually the right choice?

Pros

The biggest benefit is that you will not need to pay for mortgage insurance if you are at 20% or above (like CMHC) on your home.
Your monthly mortgage payments will be less than if you had a high-ratio mortgage.
Reduces risk if you can not pay back to loan or have to sell and housing prices have dropped.

Cons

There is a large upfront cost. 20% of a house is not affordable for everyone. Buying a $400,000 home means that you need to have $80,000 sitting around. This is a big challenge for first time home buyers.
That money is sitting in the house instead of being invested elsewhere.

2. 5% Down Payment

This is the lowest amount that you could put toward a mortgage (in most cases), and doing so put you in the category of a “high-ratio” mortgage. When you put less than 20% into a down payment you will need to get CMHC insurance (Genworth or AIG or also options, but their rates are usually worse). Basically, a premium is added on top op your mortgage

Here is the basic example; You buy a house for $300,000 and put 5% down ($15,000). For CHMC to insure your mortgage they require a 4% premium on the amount owed ($285,000). 4% of $285,000 is $11,400. This $11,400 is added to the mortgage total so your mortgage becomes $296,400. In this example you are adding an extra $38 a month to your mortgage payments. If you want to learn more about this the Government of Canada has an article all about it here.

So is it worth doing this?

Pros

You get into a home sooner. For many first time home owners, this is the only way to get into owning their first home in a reasonable time.
Instead of having that excess money sitting in your house, you could invest it in another property (or other wise investment).

Cons

CMHC is an added cost.
Only putting 5% down means that your mortgage payments will cost you more.
You have to live in the house (upstairs or downstairs suite) to be allowed to take advantage of the 5% down option. You can however move out of the home after a short period of time and still reap the 5% downpayment benefits.

3. Put as much as you can down

This option involves putting as much as you can into the down payment of your home (or just paying for the whole house in cash). For those of you who absolutely hate the feeling of being in debt then this could be a wise choice for you.

Pros

The more money you put down, the less interest you pay.
Your monthly mortgage payments will cost much less.
You will gain more monthly income from the house sooner.

Cons

The money that you have in the house in not being invested elsewhere.
Most people cannot afford to put a large lump sum of money into a home.

What is the right option for you?

The answer to this question ultimately depends on a few factors. Mainly being your current age, available funds, and your risk tolerance.

If you are a younger person, who has more tolerance to risk, I would recommend putting 5% into a downpayment. The CMHC, and higher monthly mortgage costs are there, but if you are investing in a home with a secondary suite, then your monthly mortgage cost sees a significant reduction. My wife and I were able to buy our first home in 2014 at 5% down, and were able to quickly save up and buy a second home in 2016 at 5% down as well. Our first home is now paying for itself, and we are paying only a third of the mortgage on the second house due to renters. Putting 5% down has allowed us to do more with our money, but it is not without its risks. If a tenant moves out, and the house is empty for a month or two, I have to foot the bill. So it is always worth while having an emergency fund on hand if you go down this route.

If you are looking to invest in homes later in your life, then I would recommend putting down as much as you can, and ultimately feel comfortable with. The goal for you is to get the homes paid off in 10-15 years instead of 25, so that you can use the income property as an income generator at, or before retirement.

Buying a house as a rental property is first an foremost an investment, and the most important thing is to think about what will give you the best value for your dollar.

Please share your thoughts in the comments below!