Should You Pay Off Your Home Buyers’ Plan Early?By Caitlin in Mortgage
When you’ve spent a lot of time searching and finally found your dream home, it can be all the more tempting to buy it no matter what the price tag might be. Before you’re able to get your feet in the door, you’ll need to put a down payment on the house. Once you’ve made an acceptable down payment, and purchased default mortgage insurance (if required), you’ll start mortgaging the house, amortizing its total value over roughly 25-35 years (this depends on several factors including whether or not you have an CMHC insured mortgage), until the home is paid in full.
Before starting this process, however, you’ll have to figure out how exactly you’re planning on financing the down payment itself. After all, depending on how expensive the house is, even a minimum 5% down payment is not a small sum of money for most people. This is where the Canadian Home Buyers’ Plan can come into play.
Down Payments and Mortgages
Before deciding which plan of action to take towards becoming a first-time homebuyer, it’s good to get an idea of what both the down payment and your upcoming mortgage will cost you in the long run.
Check out our infographic: The Cost of Buying a House in Canada.
As of February 15th, 2016, some notable changes to Canadian Housing Rules, and in turn, the down payment system on houses, have been put into effect to ensure that potential homebuyers don’t get stuck with mortgages they can’t afford. For instance:
- Homes with a value of $500,000 or less now require a minimum down payment of 5% of the total price.
- Homes that cost between $500,000 – $1,000,000 now require a minimum down payment of 5% of the first $500,000, and an additional 10% of the balance remaining.
- For homes that are valued at $1,000,000 or more, a down payment of at least 20% is required.
Now we’ll move on to mortgages. There are two different types of mortgages you can choose from:
- A Conventional Mortgage – means that a homebuyer will be making a down payment of 20% or more on their house.
- A High-Ratio Mortgage – means that a homebuyer will be making a down payment between 5% – 19.99% on their house.
Depending on its location and what shape it’s in, a typical suburban household will likely cost well over $350,000. More than double that price if you’re trying to buy a house in or around one of Canada’s major cities like Vancouver or Toronto, where a run-of-the-mill two-story bungalow can command over $1,000,000. With prices like that in mind and all the other costs associated with a house, it’s common for most first-time homebuyers to make a down payment of less than 20%. While it’s probably best to make a payment higher than 20%, their current income might not allow it, so they’ll need to be more realistic. A high-ratio mortgage is often a more affordable option, but in this case, the homebuyer will likely be making their monthly payments over a longer period of time than someone with a conventional mortgage.
Looking for advice on how to pay off your mortgage early? Read this.
Those with a high-ratio mortgage will also need to qualify for, then purchase “mortgage default insurance” from one of Canada’s mortgage insurance providers. The three major providers in Canada are, C.M.H.C. (Canadian Mortgage and Housing Corporation), Genworth Financial Canada and Canada Guaranty. The insurance premium a homebuyer must pay will range in accordance with the percentage of their down payment and how much they’re planning on borrowing from their lender.
Read our other article for more information about high ratio mortgages and default mortgage insurance.
What is the Canadian Home Buyers’ Plan?
As we mentioned earlier, the down payment portion of a mortgage is where the Canadian Home Buyers’ Plan will come in handy for many first-time homebuyers. The HBP is a type of program, wherein those eligible homebuyers contact the Canada Revenue Agency, fill out form T1036, and are then able to extract up to $25,000 from their R.R.S.P. account, tax-free, within one tax year. If they have one, their spouse or partner can also take up to $25,000 from their own account. They can then use these funds to finance a down payment on their new home. However, after they’ve withdrawn the money, by the second year following that withdrawal, they’ll need to start paying it back into their RRSP. They’ll also have to pay back the full sum of the extracted funds within 15 years or face certain tax penalties.
For more information about Canada’s RRSP Home Buyer’s Plan, read this.
Is it Better to Withdraw the Funds from Your RRSP or Your TFSA?
Unfortunately, in today’s housing market, even the full amount that you’re allowed to withdraw from your RRSP ($25,000) is not a huge amount when coupled with all the other housing costs you’ll need to cover. For example, if your home costs $400,000, that $25,000 is going to cover about 16%. While this is enough to finance a down payment for a high-ratio mortgage, you could be left with nothing in your RRSP account to retire comfortably in your later years, until you’ve managed to pay it back in full.
Then again, one beneficial aspect of using the RRSP Home Buyers’ Plan is that you’ll become eligible for a tax deduction because of it. You can then reinvest the money you receive from that deduction into your RRSP.
Having Trouble Figuring Out Your RRSP? Click here.
All things considered, some real estate experts are now saying that it can be more beneficial for your overall financial future to withdraw the necessary funds from your Tax-Free Savings Account instead of your RRSP. True, taking the cash from your savings comes with its own drawbacks, mainly that you’ll be dipping into money you could be using for things in your life other than your future retirement. However, one major advantage for a lot of people here is that they won’t have a specific timeframe within which they’re required to pay back the money they withdrew. So, remember to take these considerations into account before you make your own decision.
Declare Your Renewed Contributions Properly
If you are planning to finance your down payment using the RRSP Home Buyers’ Plan, there is one thing that you absolutely need to do. As you gradually pay the money back into your RRSP account, you’ll need to make sure that your contributions are declared as such to the Canada Revenue Agency. Home buyers have made this mistake in the past, accidentally contributing to their regular RRSP account only to suddenly end up in default on their HBP loan. So, the CRA needs to be aware that your renewed RRSP contributions are going towards repaying the Home Buyer’s Plan, and not into your regular account.
The Benefits of Paying Your HBP Early
Let’s say that you’ve decided to withdraw the maximum amount from your RRSP account: $25,000. For the sake of argument, you’ll then be planning on paying it back within the allotted 15 years in minimum payments. 25,000/15 = $1,666.66 per year.
However, if you decide to put forth a bit of extra income and round your payments up to $2,000 yearly, you’ll end up paying the money back in roughly 12.5 years. Anything you add from that point on will just be extra contributions to your regular RRSP fund. Although this is not a realistic goal for everyone, if you want, you can even pay more over a few years, then pay less for the remainder of the time. For example: if you manage to pay back $5,000 year for 3 years, you’ll have replenished $15,000. With $10,000 remaining, you can then lower your payments back down to $2,000, and 5 years later, your RRSP account will be fully replenished. The quicker you pay, the sooner you can get back to concentrating on saving for your retirement.
For further information on how to repay your HBP contributions to your RRSP, visit the Canada Revenue Agency website.
The Drawbacks of Re-Contributing More than the Minimum Amount
The drawbacks of paying more than the minimum yearly payments back into your RRSP are the same that come with any type of loan payment plan, whether it’s for a mortgage, car payment, or your Home Buyers’ Plan.
In the end, you will indeed have paid off your HBP early and can get back to spending your money elsewhere. However, that extra $334.34 that you’ve been adding to your RRSP repayments could have been used for the mortgage payments themselves. You could have been putting them into your regular RRSP, where they would have gained some interest over time and helped you retire a few years earlier. They might also have been better spent on other expenses like your car payments, student debt or even your general day-to-day expenses such as groceries and household products, which you will now need a loan to cover.
So, is it Better to Pay Off Your HBP Early?
This really depends on your annual income and how responsible of a saver, budgeter, and spender you happen to be. Just remember, a house is one of the biggest responsibilities most people will take on in their lifetime, especially from a financial standpoint. During the course of your life as a homeowner, you will certainly encounter expenses that go beyond the cost of your mortgage. Which means it may be in your best interest to have at least some readily available money to help cover any number of costs.
Because of this, if you’re thinking about going with the RRSP Home Buyers’ Plan to finance your down payment, instead of by other means, the choice to pay it off earlier or on schedule will both come with benefits and drawbacks. So, before making this big decision, it’s very important to review your finances, discuss all the possibilities with your spouse or partner (if you have one), then talk to a financial advisor for a second opinion.