Financial Math – The 5% House Down-Payment

Updated:  February 28, 2022.  When this article was written, housing growth was historically low.  During the past two years, the housing market has grown dramatically and the possibility of building equity may happen more quickly in today’s housing market.

We grow up in a culture where home ownership is a common and significant goal…having our own space that we can customize to our own tastes…a significant investment that will be beneficial in retirement.

The reality is that home ownership can be the root of a myriad of problems, one of which is tied to the 5% down-payment. With mortgage insurance, you can buy a house with only a 5% down-payment.  Mortgage insurance is actually required whenever your down-payment is 20% or less of the purchase price.

Think about this. With a down-payment of between 5% and 9.99%, the mortgage insurance will cost 3.6% of the mortgage amount.  They kindly add this insurance premium to your mortgage.  So, for a $200,000 house purchase with a $10,000 (5%) down-payment, your mortgage would be $190,000 plus the mortgage insurance premium of $6,840 for a total of $196,840.  In this case, your real equity in the house is $3,160 or just over 1.5% of the purchase price.  Then, if you made a mistake or circumstances change and you can’t keep the house anymore, you will need to sell it for at least $209,000 just to cover a 5% (+HST) real estate commission and the mortgage (now including the mortgage insurance premium).  If the mortgage has a pre-payment penalty this will further increase the amount that you need to sell the house for and then there will likely be some legal costs to increase the break-even to an even higher amount.

Assuming a 2.5% interest rate and 25 year amortization period, your mortgage payment, on the $196,840 mortgage loan, would be approximately $881 per month. If house prices stay flat (don’t go up) and you can only get $200,000 for your house, you would have to pay your mortgage for at least two years before you would break-even on a sale assuming the 5% real estate commission.  Again, if there is a pre-payment penalty, it would take even longer.  If house prices go down, you need to pay even longer before you can break-even.

I will let you look into your crystal ball to see where house prices are going. Mine says they are not going-up anytime soon.  Assuming house prices stay flat, if you are going to buy a house with a 5% down-payment, you need to understand that you will need to live in that house (and pay the mortgage) for at least two years (likely longer) before you can sell just to break-even.  If you need to sell sooner, you may have difficulty getting enough to cover the costs of sale and the mortgage.

If house prices don’t go up in the medium to long-term, the only equity you will build is from paying down principal on your mortgage.  It seems that a lot of people take the equity out of their homes with home equity lines of credit or refinancing to higher amounts and never really build any equity.  They also, potentially, keep their break-even point too high so that they cannot sell their house except at a loss.

I’m not suggesting that people don’t buy houses.  I just want them to understand the nature of the investment and how long it will take to get to a break-even position and start building equity.  The 5% down-payment is just one issue that house buyers should understand.  I have more house ownership issues that I will address in a future article.

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