These days, a down payment on a home is a substantial amount of money, especially if you’re a first time home buyer in Ontario or British Columbia. Ideally, you will save 20% to 25% of a home’s purchase price as the down payment, but given today’s housing prices, this can take a bit of time. There are saving strategies that can help, just as there are down payment options that can hurt. Learning how to save for a down payment on a home can get you ahead of the home buying curve.
According to a 2017 survey from Mortgage Pros Canada 51% of Canadians who bought a home between 2014 and 2015 used their own savings. Most of these home buyers protected that money using their Tax-Free Savings Account or, if they were first time home buyers they borrowed from their RRSP through the Home Buyer’s Plan. Others received financial help from family members. However, a growing percentage of Canadians funded their down payment through a separate loan. Often known as a shadow loan, these private-lending mortgages come with much higher interest rates — and are very dangerous for those already struggling to manage debt.
Whether you’re well on your way to saving for your home purchase goal, or just starting out, here’s what you need to know about the risks and rewards when saving for a down payment.
1. Home Buyer’s Plan (Using your RRSP)
Ten percent of Canadian home buyers used the Home Buyers’ Plan (HBP) to fund their down payment. The HBP is a government program which allows you to take money out of your Registered Retirement Savings Plan to buy, or even build, a home. The maximum amount you can withdraw from your RRSP is $25 000 per person (or $50,000 per couple). You have 15 years to pay the loan back into your RRSP and all payments are interest-free. To be eligible for the program you either need to be a first time home buyer or not a property owner for the last five years.
There are a few caveats that you need to understand before you take advantage of the home buyer’s plan. The total amount you can take out is $25,000, but you will lose out on the contribution room to your RRSP, plus you’ll miss out on the compound interest earned on the money had you left it in your RRSP.
As a tax-free loan to yourself, you don’t have to start paying down the debt until two years after you withdraw the money. Your repayments will be made in installments that are equal to 1/15th of the total amount borrowed. Keep in mind, though, if you miss one of these annual payments, that sum is added to your annual income and taxed at your marginal tax rate.
If you do choose to use the Home Buyer’s Plan, be sure that you’re designating your repayments as repayments (here’s how). If you don’t, the money you deposit will count as a normal contribution and you will be taxed on the amount you were to pay as part of the HBP repayment program.
Tip: If you find that your home purchase or build falls through, don’t forget to deposit the HBP money back into your RRSP, as soon as possible. A Statistics Canada report found that a portion of people who defaulted on their Home Buyer’s Plan — didn’t buy a home, but didn’t repay their RRSP account — did so in the same year. Sadly, these people were taxed on the full withdrawal sum. Rather than have the burden of that large tax bill, repay the RRSP money as soon as possible. Even if you only have a portion of the money, some repayment is better than no repayment.
2. Tax-Free Savings Account
TFSAs were introduced by the Canadian government in 2009. The biggest advantage of a TFSA is that the money that you earn inside of the account (either as interest, dividends or capital gains) is not subject to tax.
When used as an account to hold money for down payment savings, the TFSA has many advantages. Unlike with an RRSP, you will not have to repay the money you take out of a TFSA. Plus, there’s no penalty when you take the money out, and you can remove all or just a portion of the money, with no tax consequences. Also, unlike with an RRSP, you gain back the contribution room a year after your TFSA withdrawal.
How much you’re allowed to contribute to your TFSA is a little complicated. For every full year that you were over 18 years of age (the year you turned 18 does not count), you gain a specific amount of contribution room, even if you didn’t use it. The key is that you must file an income tax return in order to be eligible. For example, if you turned 19 in 2009 and have never had a TFSA, then you would have $57,500 in contribution room as of 2018. You can find out your exact TFSA contribution room from the Tax Information Phone Service or your Canada Revenue Agency account.
Any earnings you make inside the TFSA does not count towards the contribution limit, so your TFSA grows unencumbered until you take out the money to pay your down payment.
3. Using Debt for a down payment
Most financial advisors will strongly recommend against using debt to as part of your down payment. While some mortgage lenders will allow you to use a personal loan, a line of credit or even a credit card for a down payment, in almost all circumstances these strategies and methods are not a good idea. At the very least, you will find that your debt ratios will be very high but you may also find that you could run into very stressful times if the cost of servicing your debt starts to increase.
4. Using loans or gifts from family
Fifteen percent of Canadian home buyers have used a gift from their family to bolster their down payment. A further 3% have used a loan from their family. If you have a generous family with the means to help you, this is an excellent option. Ideally, any situation where money is given with an expectation of repayment, it’s a good idea for all involved to sign a written agreement. Plus, most lenders will require a signed statement stating whether the money was a gift or a loan. Why? Because the assumption is the money is a loan, unless otherwise stated. In one high profile case, a son tried to sue his mother after he was supposedly gifted $30,000 for a down payment on a house. In the end, the son lost the court battle and had to repay his mother, but it’s a stark reminder of how important it is to get these matters in writing.
Also, keep in mind that most lenders will only accept gifted down payments if they are from an immediate family member. This family member will need to write a “gift letter” to the bank to prove the funds are not a loan. If the family member refuses to sign this letter, the lender will consider the gift a loan (even it’s not) and the money will be added to your debt, which may prevent you from qualifying for a mortgage.
Despite what you might hear, the entire down payment you use to purchase a home may be gifted money, unless, that is, you are self-employed. In that case, at least 5% of the down payment money must come from your own savings.
No matter what strategy or investment tool you opt to use, just remember to be perfectly clear with your mortgage broker and lender about where the money is coming from. Ultimately, honesty is the best way to prevent incurring more debt than you can handle.
Now you have four new tips on how to save for a down payment on a home to ease your first time home buying experience. Save smartly and enjoy the process of buying a home!