Friday, September 19, 2008

The Case for Saving

For those with no down payment this post will present the case for saving and buying a home with more reasonable terms, as opposed to buying before Oct 15th when the new mortgage rules kick in.

I will compare the following options:

1. Buying a house for $300,000 now with 0% down and 40 year amortization

2. Buying a house for $300,000 next year with 5% down and 25 year amortization. The down payment will be saved into RRSPs and withdrawn using the first time home buyers program.

1. According to this table CMHC fees will be 3.1 + 0.6 = 3.7% of the loan amount. Total loan amount $300,000 + $11,100 = $311,100.

2. Rent instead and put $1250 per month (if possible) into GICs. After 1 year you will have saved $15,000 for a down payment. Also assuming a 26% top tax bracket you would get $3900 in tax savings (some of this refund in 2008 and some in 2009).

After 1 year track record of saving it is more likely you will be able to stomach the shorter amortization of 25 years. This combined with the down payment of 5% will reduce the CMHC fees to 2.75%. Total mortgage amount $300,000 - $15,000 + $7,388 = $292,838. Although the monthly payments will be higher the amount save in interest is substantial.

Down Payment Saved
Option 1: $0
Option 2: $15,000

CMHC fees
Option 1: $11,100
Option 2: $7,388

Mortgage Balance
Option 1: $311,100
Option 2: $292,838

Potential Tax Rebate
Option 1: $0
Option 2: $3900

Monthly Payment (assuming 5% rate from RBC calculator)
Option 1: $1490
Option 2: $1703

Total Interest Payments
Option 1: $403,887 (ouch!)
Option 2: $218,107

Year Mortgage Free
Option 1: 2048
Option 2: 2034

Bottom line is that option 2 is more than reasonable and you don't have to be a doom and gloomer or get a return on your savings! The same concept applies with any reduction in amortization and increase in down payment up to 20%.

Note: This comparison assumes flat home prices for 1 year and no return on RRSPs. Also see previous post comparing 25 and 40 year amortization.

No comments: