The opportunity cost of a down payment

What opportunity cost means here

Opportunity cost is the value of the next-best use of your money. A down payment sits in the home as equity. It grows or shrinks with the home's price and reduces the mortgage you borrow, but you cannot also hold it in an investment account. The renter, by contrast, keeps that cash invested.

This is why a fair comparison gives the renter the same starting cash the buyer spends. If the renter did not invest the down payment, the comparison would treat it as if it vanished on the owner's side but not on the renter's.

How big can the effect be?

Take a $600,000 home with 20% down, so a $120,000 down payment. In the calculator the buyer's total upfront cash is $126,380: the $120,000, plus $4,880 of closing costs and $1,500 of moving. Suppose that cash could instead earn 5.5% a year, an illustrative assumption and not a forecast.

Over ten years, $126,380 compounding at 5.5% grows to about $215,875. The down payment alone, $120,000, would grow to about $204,977. These are the amounts the renter's starting investment has to match, before any monthly contributions.

The down payment is only one side

The owner's down payment is not idle. It buys a home that, in the example, appreciates at 3.5% a year, and it reduces borrowing. The more you put down, the less mortgage interest you pay at 4.5%. So each extra dollar you put down earns an implicit return equal to your mortgage rate, because it saves interest at that rate. Price growth, by contrast, accrues on the whole home whatever the size of your down payment.

That means the real contest is mortgage rate versus investment return. If the investments you would use earn more than your mortgage costs, tying up less cash in the home helps. If they earn less, paying more down tends to be the better use of money.

How the down payment size changes the result

Holding the $600,000 price and other inputs fixed, the calculator gives these ten-year results for different down payments. Below 20% down, mortgage default insurance applies, with the premium usually added to the loan: 4.00% of the loan for 5% to 9.99% down and 3.10% for 10% to 14.99% down. On a $600,000 home the federal minimum down payment is $35,000, which is 5% of the first $500,000 plus 10% of the rest.

Why 20% down looks best in this example

Under these inputs, 20% down beats both smaller and larger down payments. Smaller down payments add an insurance premium, which is $22,600 in the minimum-down case, and a bigger loan at 4.5%. The freed-up cash earns only 5.5% in the renter's account, not enough to cover that drag. Larger down payments, such as 35%, put more cash to work at an effective 4.5% (the interest it saves) instead of the 5.5% the renter's account earns, so the result slips from +$41,686 to +$32,287.

The pattern would change with different rates. These numbers are a worked illustration and not a rule that 20% is always optimal. Test your own mortgage rate and investment assumptions in the down payment vs invest tool.

How much the investment return matters

With 20% down and the other inputs unchanged, the ten-year buyer-minus-renter difference responds sharply to the return the renter earns:

Risk, taxes and registered accounts

Comparing a certain mortgage rate with an uncertain investment return is not apples to apples. A guaranteed 4.5% saving on interest is not the same as a 5.5% expected return that can be negative in any year. Taxes also matter: returns in a taxable account are reduced by tax, while TFSA, RRSP and FHSA savings compound tax-free or tax-deferred. Renters can use that room too.

If you are saving for a first home, the FHSA allows $8,000 a year and $40,000 in total with deductible contributions and tax-free qualifying withdrawals, and the RRSP Home Buyers' Plan lets you withdraw up to $60,000 per person, repaid over time. Check the current rules before relying on either. The guide on down payment sources covers these in more detail.