How much and the best way to save for a down payment.
There is the old saying that owning is always better then renting and that is not always true. I want to help you navigate the financial situation of buying and owning a home and what is the best option for your individual situation. I am pro home ownership and pro renting as it depends on your situation and what your future plans are. My goal is to help you get to your future plans as fast as possible by putting your money to work for you.
When wanting to buy a house a car or anything that you need to take out a loan there are a number of things that you will want to take into account. One is getting rid of your current debt. This would be credit card debt, student loans, line of credits etc. The second step is to make sure that you have a good credit rating. There are different ways to build up your credit rating which will be discussed in another Blog. The next step is going to work with a good Mortgage broker. They specialize in getting you the best rates possible as they work with many different lenders but also give you strategies that you can work on to get your debt down and your credit rating up so that you can possibly afford more house.
Once you have good credit and your debts paid off then it is time to start saving up for a down payment.
How much money should you save up? That is a good question as it all depends on how long you plan to be in that house. There is a breakeven point to where saving and renting vs buying and owning makes sense and vice versa. For example if you only put 5% down then you are paying an extra 4% for mortgage insurance. So on a $300,000 home you are paying for an extra $11,400, if you are putting 10% down then you are paying an extra 3.1% or $8,370 on a $300,000, if you are putting 15% down then you are paying an extra 2.8% or $7,140 on a $300,000, if you are putting 20% down then you are paying an extra 0% as most lenders do not require mortgage insurance at that point.
So now you need to take a look at what that breakeven point is for how long you plan to live in that house. Is it a starter home that you are only planning on living in for 3 years then selling and upgrading to a new larger more expensive home? In this case you would have paid off the extra CMHC insurance and haven’t even touched the actual cost of the home. Or are you planning on living in that home for the next 25 plus years? The other large factor is how fast are you able to save up for a larger down payment and what is the difference in payments between your rent and what your home costs would be. These are factors that should affect your decision. A good financial advisor can help you with this decision.
Once you have figured out that it is definitely in your best interest to purchase a home you should find out what is the best, most efficient, fastest way to save up for your down payment. There are two main ways in which it makes sense to do this. One is using your Tax Free Savings Account (TFSA) and the other is using your RRSP through the home buyers plan. I will go through the differences between the two and what would work best in your different situations.
Using your TFSA you can start depositing your money into the account and watch it grow tax free. You can invest it in numerous different funds, stocks, bonds etc. Before investing you should go through your risk tolerance and understand where you are putting your money and what the benefits/risks are. The benefits of a TFSA is that you can deposit the money at any time up to a total of $52,000 of total deposits from 2009 to 2017. Once you take the money out there is no obligation to pay it back and you do not pay any taxes. Depending on your lifestyle and your habits this can also be a risk for you as there is nothing stopping you from using it towards something fun like a trip or new clothes or anything else that is not getting you towards the goal of buying a house. So you need to make sure that you are disciplined enough to say that this is for a down payment and use it for that. On the flip side if you have said that $2,000 in that TFSA is earmarked for a trip and you are waiting until it grows to $3,000 then use it for a trip as you are still working towards your plan your way.
Using your RRSP can be beneficial as you are able to borrow up to $25,000 from your RRSP to use in buying or building your first home tax free. You need to be considered a first-time home buyer. For a definition click HERE. Other conditions is you must be a resident of Canada, you cannot withdraw more than $25,000. The bonus of doing it this way is that by putting your money into an RRSP you get to use the tax rebates to help you get to your goal faster and since it is in an RRSP you cannot take it out as easily as you will need to pay taxes if you do. This way it forces you to leave your money in the account for your desired purpose. The drawbacks is that you have to repay the full amount back in 15 years. Your payments start the second year after you had withdrawn the funds to purchase your home. Each year CRA will send you a statement of your account with what you need to pay each year. If you do not pay back the portion that is required in a given year then you need to claim RRSP income for the difference that year. For example if you were supposed to pay back $1,000 that year and you pay nothing back into your RRSP you must take $1,000 of RRSP income and pay taxes on that which then nullifies your tax rebates in the previous year’s especially if you are in a higher income tax bracket. If you pay back $500 then you would claim the difference or $500 of RRSP income in that year. You will also lose that RRSP contribution room as once it’s used you don’t get it back unlike a TFSA.
So as you can see there are many different options to think about when buying your first home. I can help you navigate the financial side of things and set you up with a good mortgage broker, real-estate agent, real-estate lawyer. Let’s make sure that your financial decisions match up with your financial and future priorities. By making the right decision for your individual situation we can get you to your richness sooner.