How Much Down Payment Needed for a Second Home?
What You Should Know
- Your down payment can be as low as 5% for a secondary home.
- Investment properties require at least a 20% down payment.
- The mortgage interest rate on your second home will be higher.
- Lenders will ensure all your debt obligations don't exceed 44% of your income.
If you're planning to buy a second home, you'll need a down payment. The down payment is the portion of the purchase price you'll pay upfront. The down payment on your second home can be as low as 5% in Canada. However, it's important to note that lower down payments will increase your mortgage fees and monthly payments. When buying a second home in Canada, the most significant influence on your down payment will be if the property is used personally or for investment income.
This article will discuss the different down payment requirements for rental and personal homes. Additionally, it will mention the best strategies for using your primary residence to fund the down payment of your second home.
Down Payment for a Second Home
Your second home down payment can be as low as 5%. However, any home value above $500,000 will require a 10% down payment. For example, if your second home is $800,000, you need a minimum 5% down payment on the first $500,000 while the next $300,000 requires 10%. This means your lowest down payment would be $55,000 (500,000*5% + $300,000*10%), or an average down payment of 6.86%. This minimum amount is possible due to CMHC mortgage default insurance, explained in more detail below.
Down payments below 20% require mortgage default insurance. It's federally required to protect your mortgage lender should you stop making mortgage payments. There are some additional CMHC requirements if you have a down payment below 20%. For example, you must have a credit score above 600 and can't buy a home over $1,000,000.
Qualifying for Your Second Home Mortgage
Your lender will be most concerned if you can handle the increased debt payments. They will evaluate your gross and total debt service ratios to determine this. These ratios show the percentage of your income going towards property and debt-related expenses. As a result, a lower ratio is better because it shows you have more income availability to handle increased debt payments.
Your Total Debt Service Ratio (TDS) will likely be the limiting factor in qualifying for your second mortgage. This ratio shows the percentage of your income going towards all debt obligations, including your primary residence. It must be below 44% to qualify for a mortgage in Canada. If you are having a hard time meeting this threshold, you could:
- Increase your income through a joint mortgage.
- Cut high-interest debt altogether, or consolidate it into a low-interest rate loan.
- Shop for secondary homes in areas with lower property taxes.
Secondary Home Lender Requirements
In addition to meeting mortgage qualification requirements, your lender will likely also have restrictions on the type of secondary home you buy. The property must be a freehold or a condominium. Timeshares, co-operative housing, pooled rentals, or locations with seasonal access are generally ineligible. The secondary residence must have a maximum of one unit, meaning you can't buy a duplex or multiplex.
Additionally, you must ensure the property has a permanent electricity source, heating, utility access, and residential zoning. You can review the Second Home Program by CMLS Financial to see more criteria examples.
Down Payment for a Rental Property
If you decide to purchase your second home as an investment property, you'll need a minimum down payment of 20%. However, you will have an easier time meeting income requirements. This is because a rental property mortgage allows you to qualify using up to 50% of the future income from the property.
Refinance for Down Payment on a Second Home
Now that you understand how much of a down payment you'll need for your second home, the next step is to get the money. If you have owned your primary residence for a few years, you can use your home equity to finance the down payment. You have a few options to do this.
Don't Forget Closing Costs!
Most people forget to factor in closing costs when buying a home in Canada. Closing costs typically range from 3% to 4% of the home purchase price. These are a range of additional expenses that are due at closing. Typical costs include property appraisal, land transfer tax, legal fees, and more. They are not included with your down payment. If you don't have the money available, make sure to borrow an additional amount to fund your closing costs.
| Second Home Price | Total Savings for Personal Home | Total Savings for Investment Property |
|---|---|---|
| $300,000 | $30,000 | $75,000 |
| $500,000 | $50,000 | $125,000 |
| $800,000 | $80,000 | $200,000 |
Cash Out Refinance
This is the best strategy for financing your second home down payment. A cash out refinance provides you with cash in exchange for extending your mortgage across more years. As a result, it will take longer to pay off your mortgage, but you will receive the cheapest cost of financing. You can borrow up to 80% of your home value through a cash out refinance. However, you will immediately begin paying interest on the borrowed amount.
However, to avoid costly mortgage-breaking penalties, it's best to refinance when your current mortgage term is up. Your mortgage term is usually a five-year agreement with your current mortgage lender. However, if you find a good deal and need the money before your mortgage term ends, you can use a second mortgage, which has a higher interest rate.
Home Equity Line of Credit
A HELOC is an excellent option if you are unsure about getting a second property or need some time to find the right one. A HELOC will not charge interest unless the money is used. You'll only need to pay interest on the amount withdrawn from your account.
If you leave the money in the account, you will not need to pay anything. This is advantageous to a cash out refinance, which charges interest immediately, and your next mortgage payment will likely increase. However, HELOC interest rates are higher than refinancing your mortgage. This is the tradeoff; flexibility for a higher interest rate.
Reverse Mortgage
A reverse mortgage allows you to borrow tax-free money from your primary home without needing to repay it until you move or die. Although reverse mortgage interest rates generally have an APR of 5%, you absorb the property appreciation while waiting to pay off the loan. If your annual property appreciation exceeds 5%, your reverse mortgage will pay itself off. You receive money today and will not need to pay it off until you leave the primary home. While you wait to pay off the loan, your home will likely increase in value.
CHIP, a primary reverse mortgage lender in Canada, has stated that you can use a reverse mortgage to buy another home. You can structure your reverse mortgage to receive a lump-sum payment and additional monthly installments. The lump sum can cover your secondary home down payment and closing costs. Additionally, the monthly installments can cover or contribute to the mortgage payments on your secondary home. You will not need to pay back the reverse mortgage until you sell the first home. However, it's strongly advised that you talk with a financial advisor before attempting this strategy.
The Bottom Line
You'll need access to a down payment saved before buying your second home. The minimum down payment typically ranges from 5% to 20% of the home value. If you're struggling to develop the down payment, there are creative ways to finance it using your existing home equity. These include a cash out refinance, HELOC or reverse mortgage. It would help if you spoke with a financial advisor to understand which strategy is best.