Thursday, July 9, 2015

Should I Use my RRSP Savings for the Down Payment?

One “hot” topic drawing various opinions is whether to withdraw RRSP savings for the down payment towards the purchase of a home.    Some lead you to believe when you do, you are robbing your retirement fund.  I believe the focus should be to find the most effective way to owning your dream home.  If “effectiveness” is the optimal strategy, what does that mean in terms of cost?

Whether you are in the lowest or highest tax bracket, don’t ignore the fact that the Home Buyer’s Plan can save you money in interest costs.  Money deposited to an RRSP can be withdrawn under the Home Buyer’s Plan without any immediate tax consequences.  Because RRSP contributions reduce your taxable income, you receive a tax refund when you file a tax return.  Whether your marginal tax rate is 26% or 44%, you have an opportunity to receive extra cash simply because you paid taxes.    

The Home Buyer’s Plan is designed so that RRSPs withdrawn using this plan must be repaid over 15 years. You may be swayed into believing you cannot afford to have an additional payment.   Seeing the math may prove otherwise.  The maximum amount withdrawn under the Home Buyer’s Plan is $25,000. This translates into an annual payment of $1,667 (or $139 per month).  The worst case scenario is if the amount isn’t repaid it’s declared as income for that year.  Using a marginal tax rate of 26%, the tax would be $433.  Whatever your reason for a cash shortfall in any particular year, coming up with $433 for taxes may be easier than $1,667. Everyone’s circumstances are different.  If yours are entirely opposite and you have the ability to repay more to Home Buyer's Plan, you are not penalized.

The significant benefit for having a greater down payment is to lower your mortgage payments.  This means you pay less interest over the life of the mortgage.  The ripple effect is you will have more money for other “things”.  When you become a home owner a new list of expenses is born: property taxes, home insurance, power, heating, water and sewer. Some of these expenses existed when you rented an apartment or a home but now there are more.  They all contribute to the cost of being a homeowner. 

Another important benefit for having a greater down payment is less reliance on CMHC (Canada Mortgage and Housing Corporation) to insure your mortgage.  These insurance premiums are calculated on the amount you borrow and are then added to the principal of your mortgage.  This link provides specific information on the cost of CMHC Mortgage Insurance to show the more you have invested into the property the lower the premium on the total loan.  Ideally, you would want to strive to save 20% for your down payment to avoid incurring CMHC fees.

The disadvantage with having only saved 5% for your down payment is the high CMHC insurance premium of 3.60%.  Basically, if you have saved only the minimum 5%, you have lost your down payment. This illustration shows how this is true for a home priced at $300,000. 

Scenario #1:
Purchase Price     $   300,000
Down Payment     $     15,000 ($300,000 x 5%)      
Mortgage              $    285,000
CMHC fees           $     10,260  ($285,000 x 3.60%)
New Mortgage      $    295,260

Scenario #2:
Purchase Price      $  300,000
Down Payment      $    60,000 ($300,000 x 20%)   
Mortgage               $  240,000

If it is important to you to become a homeowner immediately, the cost of $10,260 may not appear significant. However, if you are in the positon where you can wait and save using an RRSP (Registered Retirement Savings) and TFSA (Tax Free Savings Account), you will achieve your goal of creating a tax saving, having a larger down payment and avoiding CMHC fees.  Imagine two couples with exactly the same incomes buying homes for the same price.  One couple has a down payment of 20% while the other has a down payment of 5%.  Which couple would you rather be?

Mortgage specialists and realtors are anxious to get you into a home.  Many will use the convincing statement, “Why rent when you can own?”  Patiently saving for your down payment may not be easy but using this mortgage calculator will help you see why doing so is worth the wait.   When you compare payment amounts using an interest rate of 2.85%, the mortgage for $240,000 will have a payment of $1,117.40/monthly compared to the mortgage for $295,260 with a payment of $1,374.68/monthly.   The difference can be used towards repaying the Home Buyer’s Plan or utility bills.  However, the true significance is the interest saving over an amortization period of 25 years.  

Whatever your situation, look at all the angles to determine whether using the Home Buyer’s Plan helps fund your down payment.  I know this talk will cause a great deal of controversy. I read articles saying “Don’t use your RRSP for a down payment.  The money should be saved for your retirement.”  My philosophy is “If the shoes fits, wear it.”  You are looking for the most effective strategy.  If building equity in your home with RRSP savings works, then do it.  You will have a jump start on your mortgage by lowering your payment and interest costs.  In the end, “you can have your cake and eat it, too!”

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