Housing prices are ticking up again, with the national average price for homes sold in September reaching $515,500, according to the Canadian Real Estate Association’s latest report.

Rising prices puts prospective home buyers into a dilemma when it comes to saving for a down payment. Putting down the minimum five percent on a $500,000 home gets you into the housing market for a reasonable $25,000. Saving up a 20 percent down payment, on the other hand, avoids costly mortgage default insurance premiums (mortgage loan insurance from Canada Mortgage and Housing Corporation).

Note that the minimum amount required for a house down payment depends on the purchase price of your home. Homes valued at $500,000 or less need a down payment of five percent, while homes valued between $500,000 and $999,999 require five percent on the first $500,000 and 10 percent for the portion above $500,000. Home buyers need to put down 20 percent on homes valued at $1 million or more.

There are pros and cons putting down more or less on your home purchase. I reached out to Robert McLister, mortgage expert and founder of RateSpy.com, to discuss house down payment options.

Pros and Cons of a 5% House Down Payment

Pros: The obvious advantage to making the minimum five percent down payment is there’s less capital required to become a homeowner and reaching that threshold requires less time to save.

“So many young buyers stay on the sidelines scrimping for a bigger down payment only to see home prices run away from them,” says McLister.

He points to the past two decades of price growth as evidence that getting into the market quicker can pay off, “provided home buyers don’t overextend themselves.”

Putting down less than 20 percent requires the buyer to purchase mortgage loan insurance to protect the lender against default. While the borrower must pay those insurance premiums, McLister says an advantage to having an insured mortgage will give you access to the lowest interest rates available.

A five percent down payment is also compatible with the First Time Home Buyers’ Incentive – the shared equity mortgage with the Government of Canada – and other governmental home subsidies.

A deliberately smaller house down payment can leave a borrower with a larger cash cushion, saving for more immediate closing costs and furnishings, or simply retaining more money for emergencies and other needs.

Another advantage is that automatic monthly mortgage payments create a forced savings plan for those who might otherwise squander that money away as a renter.

Cons: The financial impact of putting the minimum amount down on your home is that it comes with a 4 percent default insurance premium. While this amount can be rolled into the mortgage, it creates a highly leveraged situation with risk of negative equity should home prices fall.

“On day one you’re almost 99 percent financed. It doesn’t take much of a home price selloff to trap you in your home, preventing a sale,” says McLister.

A five percent down payment also means more interest expense over the life of your mortgage, compared to a larger down payment.

Note that the amortization for buyers with 5 percent down is limited to 25 years. The property also cannot be a non-owner-occupied rental property.

Another caveat to consider: Prospective home buyers can borrow the 5 percent down payment (even from a credit card) so long as they meet the lender’s debt limit ratio. This means, “they can essentially owe more than their home price on day one,” says McLister.

Pros and Cons of a 10% House Down Payment

Pros: A down payment of 10 percent gets you all of the benefits of a 5 percent down payment, plus saves you money on insurance premiums (borrowers pay 3.1 percent instead of 4 percent).

An increased down payment also allows you buy a more expensive home. For instance, a 7.5 percent down payment makes it possible to purchase a $999,999 home.

Finally, a 10 percent down payment increases the chance you’ll be able to refinance at the end of a 5-year fixed term. That’s because refinancing typically requires a loan-to-value (LTV) ratio of 80 percent or less.

Cons: A 10 percent house down payment still means the borrower must pay mortgage default insurance premiums of 3.1 percent.

Your purchase price is also capped at $1 million, while your amortization is limited to 25 years. The property cannot be a non-owner-occupied rental property.

Also consider that 10 percent is the minimum down payment if

• The home has 3-4 units
• You want an insured stated income mortgage (for self-employed borrowers who can’t prove their income in the standard fashion)
• You’re buying a non-winterized or seasonal access vacation property

Pros and Cons of a 20% House Down Payment

Pros: The primary advantage of putting down 20 percent or more on your home is to avoid default insurance premiums, saving you thousands of dollars over the life of your mortgage.

A larger down payment offers more flexibility, giving buyers the ability to purchase a home priced at $1 million or more, and allowing for amortizations over 25 years, along with refinancing.

Putting 20 percent down gives buyers more product choices, such as re-advanceable mortgages, standalone home equity lines of credit, interest-only mortgages, and non-prime financing.

More importantly, buyers with 20 percent down avoid the federal mortgage stress tests if the borrower uses a credit union or alternative lender.

Cons: A 20 percent down payment ties up more of an investor’s capital, which comes with an opportunity cost.

It also subjects most borrowers to a stricter stress test, since the mortgage would be uninsured.

“The uninsured stress test equals the greater of the benchmark rate or your contract rate + two percent, whereas the insured stress test is just the benchmark rate,” says McLister.

Finally, a 20 percent deposit is typically required for many new build properties.

Final Thoughts

In summary, McLister says the size of your house down payment shouldn’t only be dictated by your available resources, but by your investment alternatives.

“Often times it makes more sense to put less down so you can allocate cash to purposes with a higher return on investment.”

My wife and I put 10 percent down when we bought our first home together in 2003. We committed to a 20 percent down payment before we built our current home in 2011. That meant waiting and saving for 18 months to come up with the cash. It was a good thing house prices didn’t run away from us like we’ve seen in Toronto and Vancouver.

One concept Couch Potato investors need to accept is that their portfolio will move up and down with the market(s). Since the essence of passive investing means tracking a particular index, or set of indices, an investor’s returns must closely mirror those of the index (minus a small fee).

That notion can be downright scary for nervous investors wondering when the next stock market crash will occur. Indeed, one of my biggest fears as a passive investing advocate is that there will be a massive correction at some point and all the investors I’ve helped move to a low cost portfolio of ETFs will blame me for their losses.

But I know that’s not rational and there’s a mountain of academic and empirical evidence to support a passive approach. That, and I sleep better at night knowing I give the best advice based on these three principles:

1. Future returns are unknowable, but the best and most reliable predictor of future returns is cost. The lower the better.
2. Active management, including the idea that market timing can deliver all of the upside while also protecting the downside, sounds better in theory than it works in practice.
3. Asset mix matters. You need to be comfortable with your portfolio mix in good times and bad to avoid panic selling and second-guessing.

That last one is important. If you’re thinking about a passive investing strategy, or have recently started one and are nervous about an inevitable correction, it might be helpful to consider the range of possible returns you’d be willing to accept.

For example, a conservative portfolio of ETFs with 70 percent bonds and 30 percent global stocks had 20-year annualized returns of 5.25 percent. Its lowest 12-month return (March 2008 to February 2009) lost 7.93 percent.

Alternatively, an aggressive portfolio of 90 percent global stocks and 10 percent bonds surprisingly had identical 20-year annualized returns of 5.25 percent. However, the dispersion of those returns was much more volatile. The worst 12-month period saw losses of 31.09 percent.

Finally, a traditional balanced portfolio made up of 60 percent global stocks and 40 percent bonds had 20-year annualized returns of 5.38 percent (the highest of the three portfolios), and saw its worst 12-month period lose 19.62 percent.

Source: Canadian Couch Potato model portfolio returns

We’ve lived through an unprecedented bull market going on now for more than 10 years. It’s perfectly normal to feel like you want a more aggressive 100/0 or 80/20 portfolio. But do you have the temperament to hold that portfolio when faced with a 30 percent drawdown? Or will you completely abandon the strategy, thinking “it’s not working anymore”?

There are many ways to implement a passive investing portfolio. I have direct experience with three of those methods, with the one-ticket solution (VEQT) in my RRSP and TFSA, the TD e-Series funds in my kids’ RESPs, and a robo-advisor solution with my wife’s Wealthsimple RRSP.

All three portfolios have had a turbulent year, suffering big losses in May and August, but otherwise gaining steadily throughout the year and more than making up for the short correction at the end of 2018. Here are my personal rates of return so far this year:

• RRSP – One-ticket ETF (VEQT) – up 13.13 percent
• TFSA – One-ticket ETF (VEQT) – up 14.36 percent
• RESP – TD e-Series funds – up 13.69 percent
• Wife’s RRSP – Wealthsimple 80/20 portfolio – up 10.4 percent

As you can see from both the data on long-term returns, and the individual returns of various portfolios, it doesn’t necessarily matter which passive portfolio you adopt. What matters is your behaviour and how you react when markets (and your portfolio) move up and down.

A passive portfolio won’t protect you from a market crash. As investors, we must accept that occasional losses are inevitable. To cope, we need to design a portfolio with an appropriate asset mix for our risk tolerance and time horizon – and have the patience to stay the course.

This Week’s Recap:

This week I wrote about five retirement planning options to help you reach your retirement goals.

Thanks to Jonathan Chevreau for sharing my thoughts in his latest piece for the Financial Post: How investors can navigate the new world of ETF overload.

And Justin Bender from PWL Capital launched his long-awaited podcast this week and included a question from me about the benefits of U.S. dollar ETFs.

Weekend Reading:

An excellent and informative piece from the How To Save Money blog on the 7 best travel insurance credit cards for people over 65.

Which Canadian rewards program is worth the most? Check out this comprehensive guide from the Credit Card Genius team.

Here’s Rob Carrick on how seniors should prepare for the day when they can no longer look after their retirement investments.

Read this complete guide to your RRSP from the Handful of Thoughts blog.

Nobel Laureate Daniel Kahneman explains why trying to convince other people to change their mind is a waste of time. It turns out, the key isn’t to apply more pressure but rather to understand:

Head over to the Farnam Street blog to listen to the full episode.

The Canadian financial advice industry needs higher standards and higher education requirements. It begs the question: Is it unethical to be incompetent?

The evidence is clear that ETFs give the best returns for investors. Here are seven strategies for maximizing returns from ETFs.

A Wealth of Common Sense blogger Ben Carlson gives a eulogy for the 60/40 balanced portfolio.

Nobody wants to lose money, so it is common to wonder what can be done to avoid the potentially negative stock returns that often come with a recession. Ben Felix explains:

Dale Roberts asks what would it take to reach F.I.R.E., and really retire early?

Finally, My Own Advisor Mark Seed answers an age old question of whether to pay down your mortgage or invest.

Have a great weekend, everyone!

A personal finance workshop held just outside of Toronto last month attracted a group of 75 financial independence seeking Canadians and Americans. This ‘Camp Mustache’ gathering was borne out of the F.I.R.E. (Financial Independence Retire Early) movement made famous by Mr. Money Mustache and has attracted followers from around the world.

The Globe and Mail’s Rob Carrick spoke at the event and came away with a newfound appreciation for the F.I.R.E. movement:

“A super-interesting group at Camp Mustache — really smart, capable people. The critics need to get over the idea that these people want to retire, full stop. They really just want to take back financial control of their lives.”

As one of those critics, my beef with F.I.R.E. has more to do with bloggers who sell the dream that, “I retired early, and so can you,” all while continuing to earn income from blogging, speaking, and book sales. But I am fascinated by real life (non-blogger) folks who are chasing F.I.R.E. and it sounds exactly like Rob Carrick describes: Smart and driven people trying to be mindful of their spending and take control of their lives.

The media in the U.S. has been all over the F.I.R.E. movement for years now, but Canadian news outlets are starting to catch on. The Toronto Star recently featured F.I.R.E. advocate Scott Reickens, who has his sights set on early retirement at age 41:

“The most magical part of the FIRE movement is the community. There are meetups all over the country, Facebook groups and a ton of people talking about this online and scrutinizing things. Impromptu meetings happen. It’s valuable to talk to people who understand this path and it’s incredible to spend time with people who have similar values. Then, you don’t have to do it alone.”

The Globe and Mail took a more critical look at the idea of retiring extremely early. One professor at the Richard Ivey School of Business had a 21-year-old student who came up with a plan to retire in his late 20s. Four years after the student’s graduation, he came back to say he had met his retirement goal through a combination of extreme savings and real estate investing and was ready to stop working at the age of 27.

Finally, a really smart take from MoneySense’s Allan Norman. He answered a reader question from a 49-year-old who found himself unexpectedly “retired” and wanted to stay that way permanently. Not only was his investment advice sound, but he challenged the reader’s early retirement ideas with a tough reality check:

“Simon, at age 49, you still have a lot of life to live. If you’re able, I’d encourage you to find a new job or career. I know you have a lot of money saved, but to stretch it over another 41 years is going to be tough. There are a lot of unknowns, including new cars to buy, trips to take and things to enjoy that will require more money. Waiting a few more years before stepping away from the workforce entirely will provide you with a safety net that will give you the financial peace of mind a comfortable retirement requires.”

I wrote about my own financial independence pursuit last week, sharing my internal struggle with when to quit my day job and go full-time as an online entrepreneur. I appreciate all of your comments, emails, tweets, messages, and words of encouragement (and caution). I’ve circled a date on the calendar and of course will let you know more when I can.

This Week’s Recap:

This week we had Victor Fong guest post about preparing for the next recession – a guide for the Canadian middle class.

In my Smart Money column at the Toronto Star I shared why you shouldn’t invest money that you’ll need in the next 3-5 years.

Promo of the Week:

Every week I get emails from readers asking about how to switch from their high-fee bank mutual funds to a robo-advisor. I’ve got a great post that outlines exactly how to transfer your RRSP to Wealthsimple, one of Canada’s leading robo-advisors.

Boomer & Echo readers get their first $10,000 of investments with no management fees for a year when they sign up for their first account at Wealthsimple.

Weekend Reading:

Stephen Weyman at Credit Card Genius shares the best credit cards of 2019 – the top one has an incredible average earn rate of 3.76 percent!

CBC Marketplace looked into credit scores and why four websites give you four different credit scores. More proof that your credit score is just a small piece of what lenders look for when evaluating loans.

Sticking with credit cards and rewards, here’s Patrick Sojka explaining how to maximize the elite benefits from the American Express Platinum card. I’m taking advantage of one of those perks right now (Gold Elite status with Marriott Bonvoy).

Rob Carrick lists five investment costs that are killing your returns, and what to do about them.

Jason Heath answers a great question – what is a pension bridge benefit and how does it work?

Here’s an incredible chart showing the impact of smartphones on the camera industry:

The iPhone comes out in 2007 and changes the camera industry. Amazing to see a 90% decline in just 10 years after growth for decades

Amazing that something can go from peak to trough in exact 10

Makes you ask- What’s the next product where this will happen? pic.twitter.com/9tMGHyYo2e

— Andrew Chen (@andrewchen) October 8, 2019

Are Canadian car owners being misled about how often a vehicle needs to be serviced? A while ago I wrote something similar about how often should you service your vehicle.

An interesting piece in the Globe and Mail: With baby boomers aging, the cost of long-term care is set to triple in the next 30 years. What’s our plan for dealing with this?

Speaking of preparation, here’s another great video by PWL Capital’s Ben Felix on preparing for the recession:

What Wealthsimple acquiring SimpleTax means and why tax preparers are the urologists of the financial world.

Adam Meyers says most Canadians know the ins and outs of an RRSP, but fewer can tell you about RRIFs, which is what happens to an RRSP when you turn 71.

How often should you rebalance your portfolios, and is now a good time to do it? Dale Roberts at Cut the Crap Investing explains.

Why single seniors get the shaft when it comes to tax breaks, and here’s how to fix this injustice:

“In retirement, couples get to take advantage of a significant tax-saving measure called pension income-splitting. Solo seniors, be they lifetime singles or people whose spouse has died, have no equivalent tax break. Given their longer lifespans on average, women are the primary victims of this discrimination.”

Legendary fighter Sugar Ray Leonard never wanted to be a boxer until his dad got sick. Here’s the incredible money story of the five-time world champion and Olympic gold medallist.

Have a great weekend, everyone!