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No-money-down mortgages

The historically low interest rates we've seen the past couple of years have been a boon to borrowers, resulting in a record number of house purchases across Canada.

Hoping to cajole even more people into the housing market, banks and other lending institutions have started peddling an innovative and unprecedented product: the no-money-down mortgage.

Also known as a cash-back mortgage, this product enables you to buy a home without having to make a down payment. Here's how it works.

Great opportunity for long-time renters
If you're a first-time home buyer, chances are you can't afford an exceptionally large down payment. Consumers that can't scare up more than 25 percent of the sum of their mortgage must get mortgage insurance, available through the Canada Mortgage and Housing Corporation (CMHC) or GE Capital Mortgage Insurance Company (GEMICO). It's done in order to protect lenders should you unexpectedly default on your mortgage.

Both CMHC and GEMICO stipulate, however, that they won't insure more than 95 percent of a mortgage, which is why home buyers have traditionally had to come up with at least five percent as a down payment.

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Even that amount can be an insurmountable obstacle for long-time renters with little savings, which has prompted many banks to intervene, offering to dole out the residual five percent of a home's value.

It isn't lending, but granting, like a gift. The idea is to give you the money up front so you can make the minimum down payment to appease the mortgage insurers. That's why it's sometimes called a cash-back mortgage. The first Canadian institution to offer it was Scotiabank, which introduced this service in April 2003.

A good deal for you, but a better one for the banks
While banks like to portray the launch of no-money-down mortgages as a humanitarian endeavour, these five-percent gifts aren't exactly charitable donations. By getting you into the market sooner, they also draft you into the mortgage cycle sooner.

On a house priced $300,000, for example, the bank will give you $15,000 up front, and then sign you up for the remaining $285,000. If you calculate the interest on that sum, it will make the bankers oodles of cash and allow them to recoup their initial "gift" many times over.

Motives aside, the no-money-down mortgage can be a blessing for first-time buyers anxious to get out of the renting rut.

"The nice thing about this five percent is not only do you not have to pay it back, but you are a little bit ahead, because you put five percent into the property," says Gillian Riley, vice-president, mortgages, at Scotiabank. "You're not sitting there, a year or two later, with no equity in the property."

This financial scheme puts reduced pressure on home buyers up front. Even so, most banks say you should be able to come up with 1.5 percent of the purchase price of the home for the sundry closing costs -- lawyer's fees, title searches, moving expenses, etc.

This type of mortgage also comes with competitive terms and rates, so taking advantage of a no-money-down mortgage doesn't necessarily mean you'll miss out on good rates offered to those with bigger down payments. To check on current rates, click here.

High insurance premiums a concern
Something else to bear in mind: the smaller your down payment, the greater your insurance premiums. If you put down 25 percent of your mortgage (i.e., you're being insured for 75 percent), CMHC or GEMICO's premiums are 0.65 percent of the mortgage.

The insurance rates rise at 75, 80, 85, 90 and 95 percent -- so, if you opt for a no-money-down mortgage (i.e., you're insured for 95 percent), the premiums are 3.25 percent. That means $9,262.50 in insurance alone on a $285,000 mortgage.

To qualify for a no-money down mortgage, you have to demonstrate a history of settling your debts and show that your earnings are sufficient to meet the monthly mortgage payments.

There's no rule stating that self-employed individuals can't take advantage of a no-money-down mortgage, but given the size of the loan, preference is given to applicants who can show a history of regular pay stubs.

Excellent credit is essential
A no-money-down mortgage might allow you to enter the market sooner, but it won't allow you to buy beyond your means. If you and your partner have combined annual earnings of $80,000 and little in savings, a $500,000 home will probably be a pipe dream whether you can make a down payment or not.

"There is no ceiling on the actual price of the home that you buy, but you still have to meet all of the credit requirements," says Grace Thrasher, communications manager at CMHC. "In the case of these new options [like no-money-down mortgages], lenders are more stringent than they would be if you were making a normal down payment, with your own cash, for 95 percent.

You do have to prove that you've been able to meet your debt requirements, and demonstrate that you have a good credit rating."

The handy thing about the no-money-down mortgage is that you can take advantage of it even if you can afford the minimum down payment. Banks don't mind -- after all, their only concern is signing you up for a nice, long mortgage term.

Says Riley, "If [buyers] already have the five percent and they want [the cash-back mortgage], they could use that five percent for renovations or to buy furniture or on the closing costs, so they're not completely squeezed."

Andre Mayer is a freelance writer in Toronto

-- Posted: Sept. 20, 2004
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