December 13, 2017
How Do I Save Up for My Down Payment?
The decision to buy your first home is a major milestone, and homeownership is a point of pride for many Canadians. The latest RBC home ownership poll reveals a majority feel buying a home is a good investment, and that 39 per cent of millennials plan to buy a home within the next two years.
However, having good job and steady income doesn’t mean you can automatically get a mortgage. In Canada, you’re required to make a down payment of at least 5 per cent of the purchase price of the home. And since houses aren’t cheap, that means you’ll need to save up for your down payment.
Set Your Savings Goal
Having a specific number to work toward will make saving easier. Think about the kind of home you’d like to own and neighbourhoods you’d like to live in, and do some research on prices. Engaging with a realtor at this point can help you get a good idea of what’s available and what the trends are in terms of prices.
Once you have an idea of how much you want to spend on a home, you’ll need to decide how much of a down payment to aim for. The minimum is 5 per cent, but you’ll be required to buy mortgage default insurance if your down payment is less than 20 per cent. Your monthly payments will also be smaller if you make a more substantial down payment. You can use a mortgage payment calculator to see how different down payments affect your equity and monthly payments based on your target purchase price.
In addition to the down payment, you’ll also need to save for the extra expenses that come with buying a home. These closing costs include lawyer fees, taxes, adjustments and other miscellanea. Closing costs typically add up to 1.5 per cent of the purchase price of the home.
If you’re looking to spend $400,000 on a home and make a 20 per cent down payment, you’ll want to save $86,000: $80,000 for your down payment, and $6,000 for closing costs.
If the prospect of saving $86,000 makes your hair turn grey, you could also consider a 5 per cent down payment, which would drop your savings goal to a more manageable $26,000 but also significantly increase your monthly mortgage payments after your purchase.
When you’ve decided on an approximate purchase price and down payment percentage, it’s time to get to work. You can work out a monthly savings amount based on your goal. Continuing the example above, you could choose to put away $3,600 a month to save $86,000 in just under two years. Or you could choose to save $550 a month to save $26,000 in four years.
While you say “bye for now” to your hard-earned money and forego vacations and avocados, there are investment vehicles and tax shelters that can help you get the most out of your savings (and maybe save a bit faster, too).
Make Your Money Work for You
Let’s start with the different types of investments you can make with your money. If you’re saving over the course of a few years, hiding your cash under the mattress will actually lose you money because of inflation. This is why it’s a good idea to invest your savings, so you can earn some money while you wait to buy a home.
You can choose to invest in markets (stocks, mutual funds, and ETFs), but this could be risky since your time horizon is so short. Instead, you might want to choose a high interest savings account. These accounts pay a high rate of interest (up to 2.5% at the time of writing), and there are several options available that don’t charge any transaction fees.
You can also choose a guaranteed investment certificate (GIC). GICs are especially helpful for this kind of savings goal because they lock in your money for a certain period of time, and pay guaranteed interest with virtually no risk. If you find yourself tempted to dip into your savings to pay for other things, GICs can be a great way of keeping yourself on track. The only downside is you can’t withdraw your money early, so if the perfect home comes up before your GIC matures, you might find yourself short on cash.
There are also some tax shelters that can help you keep the proceeds of your investment in your hands, and out of the government’s.
First is the tax-free savings account (TFSA). TFSAs allow you to make all kinds of investments, but exempt you from paying tax on the investment returns. This is especially beneficial if you’re in a higher tax bracket, because a lot of your investment income can be eaten up by tax if you’re using a non-registered account.
But the tax shelter first-time homebuyers should be most excited about is the registered retirement savings plan (RRSP). There’s a program within the RRSP called the home buyers’ plan, or HBP. The HBP allows you to withdraw money tax free from your RRSP to buy your first home. You can withdraw up to $25,000, and if you’re buying a home with a partner who’s also a first-time homebuyer, they can withdraw up to $25,000 from their RRSP as well.
The best thing about the HBP is that RRSP contributions are deducted from your income tax. Say you deposit $5,000 in your RRSP and your marginal tax rate is 30%. You would get a $1,500 tax credit for making that contribution. You can reinvest that money and get a big bonus on your savings. In fact, at a marginal tax rate of 30% you might only need to save $19,230 of pre-tax money to get your RRSP value up to $25,000. Of course, your results will vary based on your unique financial situation.
The catch is that you have to pay yourself back over the course of 15 years. If you withdraw the full $25,000 you’ll need to contribute $1,667 to your RRSP every year for 15 years to pay yourself back. And you won’t get the tax refund on those repayments.
You should also be warned if you plan to use the HBP, there’s an opportunity cost involved. The money you take out of your RRSP could earn a lot more interest if it stays invested. $25,000 invested with a 6% rate of return for 15 years will grow to be worth $59,914. If you start at $0 and contribute $1,667 per year, your money will only be worth $41,121 after 15 years.
If you use the HBP, you’ll also want to make sure you set aside some money in a more accessible account to facilitate your home purchase. Typically, when you make an offer on a home you need to make a deposit of several thousand dollars or more. But in order make an RRSP withdrawal under the home buyers’ plan, you need to have entered into an agreement to buy a home. If all of your money is tied up in your RRSP, you might have a hard time finding enough cash for a deposit. Your realtor can help you understand what kind of deposits might be necessary in your market so you can plan ahead.
Whether you choose to use a TFSA or RRSP (or a combination of both) to save for your down payment, you should be aware of the rules involved. Most notably, there are annual contribution limits. If you’ve never put money in a TFSA or RRSP you’re probably not going to blow past your limit even with a significant investment, but take some time to find out what your limit is and make sure you stay below it.
The Bottom Line
Saving for a down payment takes patience and discipline, but it can pay off in the long run. And fortunately there are many options available to help you grow your savings faster. Do some research, set your goals, and take advantage of tax shelters to maximize your savings.