What’s the Difference Between Down Payments and Deposits?
When you purchase a home, you will need to have some money available in order to secure the offer to purchase (deposit) and to qualify for a mortgage (down payment).
What is a Deposit?
A deposit is an indication that you, the Buyer, has a sincere interest in buying the home from the Seller. A typical deposit is 5% of the purchase price, though your offer to buy the home is typically stronger if you offer more money to the Seller. In Multiple Offer situations, increasing your deposit can help set yourself apart from the other Buyer’s hoping to buy the home.
The amount of the deposit is noted on the contract of purchase and sale, and when all subjects are removed and the contract becomes firm (typically a week after the accepted offer), you have to give your Realtor a bank draft with this amount, which is held in trust with the Seller’s Real Estate Brokerage until the home completes (when the Seller is paid and the Buyer gains possessions). The deposit forms part of the purchase price.
If the Seller’s don’t get access to the deposit until the house sells, why do they care about the amount of the deposit? In unfortunate (and rare) situations where the contract to purchase the home is terminated after subjects are removed, the Seller may be able to keep the deposit if they are able to prove that the Buyer didn’t fulfill their obligations. For example, if the Seller has to pay for this home and a home they have already purchased they would (probably) get to keep the deposit since the Buyer did not fulfill what was promised. The case is taken to mediation where it is decided who gets to keep the deposit.
What is a Down Payment?
When you purchase a home, the down payment is the portion of the purchase price that you pay for, with the rest of the home being financed by a mortgage loan. Banks will NOT finance the entire purchase price of the home so you have to prove that you want this home and have some funds indicating that you can afford it. Remember, you’re charged interest on the amount of your mortgage loan, so the higher the down payment, the lower your mortgage will be (and the less interest you’ll pay in the long run). The minimum down payment in Canada is 5% of the purchase price; less than 20% is a high ratio mortgage so you have to also pay for mortgage insurance (this is the Bank’s way of protecting their interest in the property). If you put down 20% (conventional mortgage), you don’t have to pay mortgage insurance. The down payment isn’t required until the completion date on your new home.
This money has to be available to you (i.e. cash that is in your bank account). If your parents are giving you money for a down payment, a letter needs to be signed by them calling it a gift, otherwise, it’s a loan, which makes you an undesirable candidate for another loan: your mortgage. This money has to be in your possession before you apply for a mortgage. You and your parents have to make a private deal in terms of when and if you will pay them back.
First-time buyers can also use their RRSP savings to help finance a down payment. You can use up to $20,000 (or $40,000 for a couple) to help pay your down payment, which you have to repay within 15 years. To do this, you need an Accepted Offer on a home and the funds have to be in your account for at least 90 days. Keep in mind that this puts a hold on the tax sheltered growth you would otherwise be accumulating in your RRSP, so this option should be discussed with your financial manager.
You have to save for a down payment the old fashioned way: living within your means and saving money with every paycheque. It can take awhile to build up that amount of money (down payments are usually tens of thousands of dollars) but you’ll eventually get there.
Down Payments and Deposits
Sale Price of the Home: $500,000
= Total payable to Seller = Deposit + Down Payment + Mortgage loan
Down Payment: $50,000
Total Payable to Seller on Completion Day: $475,000
= Price of Home – Deposit (already paid)
Total Mortgage: $425,000
Simply Put: The deposit is a part of your offer to purchase the home, the down payment affects your mortgage used to finance the purchase.