Saving a Down Payment

Renting sucks, but sometimes it's the key to starting off on the right foot.

Good morning! 

Welcome to any new friends who have subscribed over the last two weeks (I've seen a bunch of new subscribers recently and I couldn't be more excited to have everyone onboard!) and welcome back to any friends who have already been along for the ride.

I had a very productive week, full of productive and efficient work at the office and great opportunities in the evenings to ponder some thoughts that needed pondering.

Not every week is like this. In fact, most weeks are not like this.

And I'm never sure of whether to feel guilty for not getting in a full eight hours of work even though I'm paid for eight hours of work, or to be extra happy when I get more than four hours of productive time in a day.

Generally, I lean towards the latter — so long as I'm productive enough in those four hours to pay for my entire day, I feel like the day is a success.

I'm genuinely curious how others approach this semi-personal dilemma each day. If you have some thoughts, let me know.

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This week is Part #3 of the "Where Should I Start?" series I've been putting together. A quick summary of the first two pieces:

This week is all about saving a down payment for a home. 

But first, some thoughts and links.

Quick Thought of the Week

In golf, nobody ever asks you how well you shot in a round. They only ask you how many shots you took.

The same can be said for your portfolio of assets. Though I'd never recommend it, if your portfolio only consists of ultra-high-value hockey cards that can be sold to meet your retirement needs, then you did it.

Your portfolio can take many different forms, shapes, and sizes. A home, cottage, stock market portfolio, and rental property portfolio are not required to live a great retirement.

They don't ask what you have. They just ask how much.

Link of the Week: What is a Moat?

This article is for the investors in the group and is a little more advanced than articles I've shared in the past. 

However, this is one of the most informative articles I've read in a long, long time. In short:

A moat is made up of a company’s sustainable competitive advantages.

How sustainable those advantages are, determines how wide or narrow the moat is.

If a company has an advantage over its competitors that they can maintain for decades, they have a wide moat. 

A no-moat company has no sustainable competitive advantages and a narrow-moat company that has some advantages that are expected to erode over the next 10 plus years or so.

This investing term “moat” was made popular by famous investors Warren Buffett and Charlie Munger.

My rule of thumb for stock market picks has always been simple: 

Do you think the company will be here in 40 years when you're ready to retire? If so, then it's probably a good buy.

A "moat" is a much better way to define my rule of thumb.

I'm going to use the word "moat" way, way too often in the coming years.

Some Things to Think About When Saving That Down Payment

You’re thinking, “Finally! After paying off expensive debts and saving a pesky emergency fund, it’s finally time to save money to purchase a house.”

You wouldn’t be wrong of course, but this is probably the most regionally-dependent step when getting started. Quite frankly, housing prices vary considerably from place to place across the country.

Take Toronto for example. New 2 or 3 bedroom condos are going for $850,000+, a near impossible hill to climb if you’re getting started. That same condo in Winnipeg would likely cost a fraction of the Toronto cost (but brings with it the perils of living in Winnipeg).

Needless to say, today’s advice should be taken with the biggest or smallest grain of salt imaginable. Apply every ounce of this to your hopes and dreams and come to a reasonable conclusion.

It's the best I can hope for.

The Required Down Payment and CMHC Insurance

Mortgage rules are pretty tight in Canada thanks to questionable lending practices around the world in the 2008 financial crisis. The result is a web of rules and requirements to navigate before you can receive the keys to a new home.

These rules and requirements are largely governed by the Canada Mortgage and Housing Corporation. This crown corporation provides mortgage insurance to your lender should you wish to purchase a property with less than 20% of the purchase price as a down payment. The insurance is specifically for the lender should you default on any mortgage payments, and the lender passes these costs onto you, the home buyer. The insurance is tacked onto the mortgage and is charged in the following increments:

  • 15%-20% down payment: 2.8% insurance premium on the mortgage amount

  • 10%-15% down payment: 3.1% premium

  • 5%-10% down payment: 4% premium

Once your insurance premium is determined, the amount is added onto the mortgage and you pay interest on the premium until you’ve paid off your mortgage. In Quebec, Ontario, and Saskatchewan, you also have to pay provincial sales tax.

There are pros and cons to paying the expensive CMHC insurance premiums.

Pros of Paying CMHC

If you dig into CMHC insurance benefits, there are two specific benefits to putting less than 20% down on a home:

  1. Interest rate discounts: By adding mortgage insurance onto your mortgage, you can secure a slightly lower mortgage interest rate. This is relatively new practice and can provide discounts from anywhere between 0.1% and 0.3%. Given how low interest rates are right now, this can amount to a sizeable discount over a 5-year term and beyond.

  2. Buying more house, faster: I’ll probably get into trouble saying this is a positive factor for CMHC fees, but hear me out: By getting into the real estate market faster, you can begin to achieve real estate returns faster than were you to save longer and put 20% down on your home. Being able to get into a larger house with more amenities is also a positive, as it will deter you from needing to flip that home down the road should your lifestyle and family change.

I’ll go into a deep-dive one day on why I think paying some CMHC insurance on a home isn’t the worst idea in the world. For now, as long as you know you are receiving some benefit for paying the mortgage insurance, then I’ve succeeded.

Cons of Paying CMHC

The obvious con to paying CMHC mortgage insurance is the cost. The cost of mortgage insurance should you put 19.99% down on a $250,000 home is $5,600 (plus applicable tax). On a $500,000 home, CMHC insurance amounts to $11,200 (plus applicable tax). And it only goes up from there should you have less than 15% or 10% down.

I know some folks get fooled into thinking this amount isn’t an overly big deal, as it’s tacked onto the mortgage and you can pay it off over time. But in the purest and simplest form:

$5,600 on a $250,000 home (or $11,200 on a $500,000 home) is an entire year’s worth of principal payments on the home. PLUS you pay interest on top of that insurance premium. Depending on how long it takes you to pay off the mortgage, that simple insurance premium could cost you two years of mortgage payments.

CMHC insurance is expensive. Plain and simple. General advice is to avoid it altogether and to put 20% down on the purchase of the home. 

The problem, as always, is more nuanced than that.

So Why the CMHC Fuss? How Much Should I Save?

Because you have to come up with a savings goal to purchase a home of your liking. And CMHC insurance is a large enough factor to consider when saving for a home.

There are many rules of thumb when determining how much home you can afford to purchase. Financial institution calculators are notorious for providing an answer that is higher than most people would be comfortable purchasing. Many standard advisors recommend a simple formula like, say, two times your family’s annual income.

If you were asking me, point blank, how much of a home you can afford when you’re starting out, I’d tend toward recommending the higher of the amounts any advisors or calculators would provide. Here’s why:

  1. Disposition (selling) and acquisition (buying) costs are expensive: Closing costs are outrageously expensive and are incurred each time a property is transacted. Costs like land transfer taxes, realtor fees, and legal fees can amount to 10% or more of a property’s purchase price. Land transfer taxes are especially egregious. By buying a larger home with more than you need right off the bat, you ensure room to grow into the home and diminish the need to find a new home if your family changes down the road.

  2. Most incomes tend to increase over time: On the same token as family situations, in my experience, most folks’ incomes tend to increase over time as well. Perhaps you increase your skills through education or you are able to achieve raises through experience. Mortgage payments only change once every five years at most, and even then they change only slightly over the lifetime of the mortgage. So if that $500 bi-weekly mortgage payment feels extremely expensive at the start, you’re likely to grow into it eventually and it’ll feel less painful over time.

If you read between the lines, I almost recommend a person starting out to be house broke for a few years. So much general advice recommends you stay away from being house broke, and I can entirely see where this advice comes from. The security of knowing you can always afford your home has a tremendous value.

But there are times where this is short-sighted as well. And, specifically, when it comes to the cost of flipping homes constantly as your income rises, as your lifestyle changes, and as your family grows, you’re likely to lose more money than anyone would care to admit.

Those professionals have to earn their livings somehow, after all.

Saving the Down Payment

Straight up, I don't think there's any magic formula for saving a down payment for a new home. Many folks I know binge-save. Every single dollar they earn is earmarked for a savings account until they have to spend it on their daily lives. It's a trying time of life, but I've always felt actually saving a down payment is easier than saving an emergency fund — the down payment is going towards something fun and towards something that signifies you're moving forward and getting ahead.

A specific asset I don't see too many folks tap into is their parents' equity. Many people in their 50s and 60s have paid off their mortgage or have considerable equity in their home. If that equity hasn't been utilized, I see no better way of controlling part of your estate than by either gifting a child money for a down payment or borrowing the child money at a preferential rate. This can be difficult if you have multiple children and want to do fairly by all of them, but the solution to that problem is just mathematics — anything you give to your children while you're here on earth is something they won't get when you pass on.

And I see no better way to kick-start your child's life than by helping them purchase a home.

I have a few other tips that I've seen work over the last few years, some of which are trends and signs of the times, and others are the realities of closing costs:

Rent longer: It will be market dependent, but there are very few rental property owners who are making actual cash flow on a rental property. In my experience, most if not all rental property earnings and gains come when the property is sold or after the mortgage has been paid off. So, on the other side of that transaction, renters can rest assured knowing they are actually living (to an extent) on their landlord's dime. As you're attempting to save cash for a down payment, cash flow is all that matters — rent longer, have the landlord pay the current cash difference, and keep your cash needs lower to maximize your down payment.

Buy too big of a home: As mentioned above, this flies in the face of all conventional wisdom, but I mean it: By purchasing more home than you initially need, you're allowing room to grow into the home, allowing room for your income to grow into the mortgage payments, and diminish your need to flip the house after a short period if your life changes. I can't stress this enough: Transaction costs are exorbitantly expensive. They'll run you a year or two of principal payments on your mortgage, even if "you know a guy". Buy more than you initially need at the start, be house broke for a very short period if you see income growth on the horizon, and eliminate your need to constantly jump from house to house.

Lengthen your mortgage term: I know general advice suggests you should aim for a 15-year or shorter mortgage — the faster you get out of debt, the better off you'll be, they say — but I disagree. There's great power in lengthening out your mortgage, providing yourself a stable monthly or bi-weekly payment, and making extra payments on the mortgage as extra money flows into your world. I call this "cash flow flexibility" — if times are tough, you have a smaller payment to meet, and if times are good, you can pay down that mortgage through extra principal payments that dramatically cut the cost of the mortgage over time. Lengthening your mortgage term also enables you to secure a larger mortgage and buy a bigger home, which should help deter the need to flip houses too often.

If Impossible, Rent

For those who find themselves in the most expensive markets, home ownership may be a farfetched dream only the Baby Boomer generation was able to achieve. Prices are eye-popping in metropolitan centres like Toronto and Vancouver, and there's no reason for a person to diminish their self-worth because of a blazing market that's out of control.

Rest assured, my thoughts about renting above should flash like a giant light bulb. Landlords and real estate owners gain most of their income through appreciation of the property. In many circumstances (especially in my area), rental properties simply don't cash flow — rental property owners have to supplement the rental account each month to ensure repairs, property tax, insurance, utilities, and the mortgage payment can all be met.

If you're in an expensive market and can't find the cash for a down payment, use this to your advantage and plow your savings into other investments. Real estate has had a long-term average growth rate of 7.1%, and the stock market is only a hair behind. 

In the end, it's all about how big you can make the snowball at the top of the hill. Once you're at the top of the hill, nobody asks what your snowball is made of.

Home ownership is not the key to long-term wealth. Don't ever let prices deter you from your long-term visions.


That, my friends, is Part #3 of my series on "Where Should I Start?" Next week, I hope to finalize this 4-part series with a discussion about how to start building wealth after you've purchased your home. I'm especially excited for Part #4; I plan to discuss the power of free trading platforms and broad-market-coverage ETFs — essentially, a "do-it-yourself mutual fund" without any of the costs.

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Thanks again for reading this lengthier issue. Hope you have a tremendous Thanksgiving weekend with your closest family members and a great week ahead.

JG