Down Payment vs Deposit: Understanding the Key Differences for Homebuyers

Down payment vs deposit: what’s the difference? Delve into these two key concepts in detail to provide clarity for homebuyers navigating the Canadian housing market.

What is a Deposit in Real Estate?

When it comes to purchasing a home in Canada, understanding the roles of a deposit and a down payment is crucial. Many prospective buyers are unclear about how these terms differ, yet they play distinct roles in real estate transactions.

A deposit is a payment made by a buyer to secure a property, usually within 24 hours of an accepted offer. This payment serves as a financial assurance that the buyer is committed to purchasing the property, helping the seller feel more confident in proceeding with the transaction.

Typically, the deposit amount is a percentage of the purchase price, usually ranging from 1% to 5%. For instance, if you’re buying a home priced at $500,000, a 1% deposit would be $5,000. While the deposit amount is negotiable, it is generally influenced by market conditions and the competitiveness of the property.

The deposit is held by the listing brokerage or the seller’s lawyer until the sale is complete. This money is kept in a trust account, ensuring that it is only released under specific circumstances.

The deposit forms part of the buyer’s overall down payment at closing. However, if the buyer backs out of the deal without meeting any conditions in place, the deposit could be forfeited.

What is a Down Payment?

A down payment is the total amount of funds a buyer puts forward towards purchasing a property. It represents a percentage of the home’s total price and is paid upfront before securing a mortgage. For instance, if you are purchasing a home priced at $700,000, a 10% down payment would amount to $70,000.

The down payment is usually the buye’s own money, sourced from savings, investments, or retirement accounts like an RRSP under the Home Buyer’s Plan (HBP). The remaining amount is then financed through a mortgage loan from a lender.

This down payment is due at the completion of the sale, when the buyer’s notary or lawyer will handle the transaction​.

For Canadian homebuyers, the minimum down payment depends on the purchase price of the home:

1. Below $500,000: Minimum 5%
2. Between $500,000 to $999,999: Minimum 5% of the first $500,000 and 10% of the amount over $500,000
3. Above $1 million: Minimum 20%​

Deposit vs Down Payment in Canada: Key Differences

Although the terms deposit and down payment are often used interchangeably, they serve different purposes within a real estate transaction. Let’s explore these distinctions of house deposit vs down payment.

Timing of Payment

The deposit is typically paid upon offer acceptance or within 24 hours, depending on the terms outlined in the purchase and sales agreement. It is submitted via a bank draft, certified cheque, or other funds held in a bank account.

In contrast, the down payment is due at the completion of the sale when real estate purchases complete, and legal fees and remaining funds are settled. A deposit is considered an initial payment, whereas the down payment is finalized during closing.

Purpose and Security

The deposit serves as a form of security to show that the buyer is serious about purchasing the home. It’s a commitment to the seller that the buyer intends to fulfill the contract terms. If the buyer backs out without meeting the conditions of the purchase agreement, the seller may keep the deposit money.

The down payment, on the other hand, represents the total upfront amount the buyer contributes to the home’s purchase price, reducing the mortgage loan amount. This amount can come from cash savings or registered retirement saving’s plan (RRSP), depending on the buyer’s financial profile.

Amount and Calculation

A deposit is usually a small percentage of the home’s purchase price, ranging from 1% to 5%. For example, if the home’s purchase price is $500,000, the minimum deposit might be $5,000 to $25,000.

The down payment, however, must meet the minimum down payment requirements set by mortgage lenders. If the total purchase price is under $500,000, the minimum down payment is 5%.

For homes priced over $500,000, buyers must contribute 10% of the portion exceeding $500,000, and for those over $1 million, a 20% down payment is mandatory. Lower down payments also require mortgage default insurance, adding another layer of costs.

Handling and Usage

Deposits are held in a trust account by the seller’s lawyer, real estate brokerage, or other legal professional until the sale is finalized.

The deposit then becomes part of the down payment. In a real estate transaction, both a deposit and a down payment are required to secure and complete the property purchase, and they differ in the way they are applied.

Payment Amounts and Timing

Both the deposit and down payment amounts can vary based on the location and market conditions. Here’s a breakdown of their payment details:

• Deposit: The deposit is not a fixed amount and can be negotiated depending on factors like property value and market competition. In a hot market, a higher deposit might be necessary to show financial strength.
• Down Payment: The down payment must meet the lender’s requirements, usually ranging from 5% to 20% of the home’s value. If the down payment is less than 20%, mortgage insurance is required.
• Timing: The deposit is due within 24 hours of subject removal, while the remaining down payment is due at the completion date when the mortgage and other closing costs are settled.

Who Receives the Deposit and Down Payment?

The recipient of the deposit and down payment varies at different stages:

• Deposit: Held by the buyer’s agent’s brokerage or a third-party lawyer until the sale closes. It ensures that the buyer remains committed to completing the purchase.
• Down Payment: The down payment is given directly to the buyer’s notary or lawyer on the closing date. The deposit amount is subtracted from the down payment, making it a part of the total funds required at completion.

The formula often used is:

Deposit + Remaining Down Payment + Mortgage = Purchase Price

For example, if the purchase price is $600,000, and the deposit is $10,000, the down payment would be calculated as:

$600,000 – $10,000 = $590,000

The remaining down payment must then be arranged along with the mortgage​.

What Happens to the Deposit if the Purchase Falls Through?

When a home purchase falls through, the outcome of the deposit can vary depending on the specific conditions stated in the purchase agreement.

The deposit, which may have been paid using a bank draft, certified cheque, or money order, serves as a financial safeguard in the home buying process. Here’s what typically happens based on the type of agreement and situation:

Conditional Offer: Protecting the Deposit

If the buyer’s conditional offer includes specific terms—such as financing approval or passing a home inspection—the initial deposit is generally protected if these conditions aren’t satisfied. In this case, the buyer can back out of the agreement without losing the deposit.

For instance, if the mortgage lender does not approve the buyer’s loan due to high mortgage rates, the buyer can void the agreement and have the deposit returned. This ensures that the buyer is not penalized for circumstances beyond their control.

Conditions may also include the ability to verify certain aspects of an investment property, such as zoning laws or the seller’s legal ownership. If these conditions are unmet, the deposit typically remains with the buyer, even though the deal falls apart.

Non-Conditional Offer: Risks of Losing the Deposit

If the purchase offer does not include conditions—often referred to as a firm or unconditional offer—the buyer’s deposit is at significant risk if the transaction does not proceed.

If the seller accepts the offer and the buyer then backs out without fulfilling the terms, the home seller can retain the deposit as compensation for lost time and potential market devaluation. In such cases, the deposit paid acts as a financial penalty for the buyer’s withdrawal.

This penalty can be severe, especially if the deposit was a larger lump sum in a competitive market with high purchase prices.

Additionally, if the seller believes they have suffered further financial damages due to the failed sale, they may pursue legal action to claim the deposit plus additional compensation.

For example, if the property’s value decreased due to changing housing corporation policies or fluctuating mortgage rates, the seller could argue for the buyer to cover these losses.

Deposits and Real Estate Jargon: Legal Implications

Understanding the real estate jargon in a purchase and sales agreement is crucial to knowing when the deposit can be forfeited. When the deposit money is paid upfront, it is placed into a trust account by the listing brokerage or the seller’s lawyer.

If the transaction does not close due to failure to meet the contract terms, this deposit becomes a form of liquidated damages for the seller. In certain circumstances, such as failing to accumulate interest on the deposit, a buyer may contest the forfeiture, but this depends on the specific terms outlined in the agreement.

Special Considerations for Real Estate Purchases

There are scenarios where the deposit is automatically returned, such as if the seller fails to meet their own obligations (e.g., the property’s title is unclear or there are legal issues).

In other cases, if a third-party legal professional reviews the transaction and determines that the buyer acted in good faith, the deposit could be returned despite the failed sale.

However, for properties that involve multiple stakeholders, such as investment properties or those with complex financing structures, the process of returning a deposit can be more complicated.

For these reasons, buyers should always review the terms and conditions in the sales agreement with their lawyer before signing. This can help ensure that any financial obligations are clearly understood, safeguarding against potential losses if the deal does not close.

Practical Tips for Buyers

• Always include conditions such as financing, inspection, and legal review in your purchase agreement.
• Verify that the home price and deposit amount align with your financial capabilities.
• Use other savings or secure a loan through a mortgage lender to ensure the total down payment is available if the deal closes.
• Consider consulting with a legal professional before submitting a deposit to fully understand the difference between a deposit and a down payment, especially in volatile markets.

Ultimately, deposits can be a complex aspect of real estate transactions, and having a clear understanding of your rights as a buyer can prevent financial losses during the home buying process.

Mortgage Loan Insurance Plan

In Canada, if your down payment is less than 20% of the purchase price, you are required to obtain mortgage default insurance, also known as CMHC insurance. This insurance is designed to protect the lender in case the buyer defaults on the mortgage.

• CMHC Insurance: Available for homes priced below $1 million.
• Premium: Varies based on the down payment amount, ranging from 0.6% to 4.5% of the total mortgage value.

If the down payment is 20% or more, no mortgage insurance is needed. For homes over $1 million, a minimum 20% down payment is required.

Home Buyers’ Plan and First Home Savings Account (FHSA)

The Canadian government offers two programs to help first-time buyers:

1. Home Buyers’ Plan (HBP): Allows first-time home buyers to withdraw up to $35,000 from their Registered Retirement Savings Plan (RRSP) ($70,000 for couples) without penalty, provided the amount is repaid within 15 years.
2. First Home Savings Account (FHSA): Allows young Canadians under 40 to save up to $40,000 tax-free for a home purchase. This initiative was launched to help address housing affordability for first-time buyers.

Provincial Down Payment Assistance Programs

Several provinces in Canada offer down payment assistance programs to help residents afford a home purchase. These programs vary by location but generally provide loans or grants to cover down payment costs. For example:

• Ontario’s Homeownership Program: Provides down payment assistance of up to 10% for eligible low-income buyers.
• BC’s First-Time Home Buyer Program: Offers a partial exemption from the property transfer tax, reducing upfront costs for first-time buyers.

These programs can be a valuable resource for prospective homeowners who may otherwise struggle to afford the upfront costs associated with buying a home.

Conclusion

Understanding the distinction between a deposit and a down payment is essential for anyone looking to buy a home in Canada. While the deposit serves as a financial commitment to secure a property, the down payment is a substantial upfront investment that determines your mortgage terms and overall purchase strategy.

Being aware of the timing, purpose, and legal implications of both payments can help you navigate the real estate process with confidence and avoid costly mistakes. Before making any financial decisions, always review the purchase agreement thoroughly and consult with a professional to ensure your investment is secure.

Conclusion

Understanding the distinction between a deposit and a down payment is essential for anyone looking to buy a home in Canada. While the deposit serves as a financial commitment to secure a property, the down payment is a substantial upfront investment that determines your mortgage terms and overall purchase strategy. Being aware of the timing, purpose, and legal implications of both payments can help you navigate the real estate process with confidence and avoid costly mistakes. Before making any financial decisions, always review the purchase agreement thoroughly and consult with a professional to ensure your investment is secure.

FAQs

What’s the Difference: Deposit vs Down Payment Canada?

A deposit is a small percentage of the home’s purchase price paid upfront to secure the property, while a down payment is a larger lump sum given at closing to reduce the mortgage loan amount. Both serve different purposes but are essential components in the home buying process in Canada​.

What happens to my deposit if the home purchase falls through?

If the home purchase falls through due to unmet conditions in your offer, such as financing approval or a failed home inspection, the deposit is usually returned to the buyer. However, if there are no conditions in place, the seller can keep the deposit as compensation and may pursue legal action for further damages.

Is a deposit part of the down payment?

Yes, the deposit is considered part of the down payment. It is paid upfront at the time of making an offer and held in trust until the deal closes. Once the sale is finalized, the deposit amount is subtracted from the total down payment due at closing.

What is the minimum down payment for homes in Canada?

The minimum down payment in Canada depends on the property’s purchase price. For homes below $500,000, a minimum of 5% is required. For properties between $500,000 and $999,999, 5% is needed for the first $500,000, and 10% for the amount above $500,000. For homes priced at $1 million or more, a minimum down payment of 20% is required.