RRSPs, HBP, Taxes and Your First Home
Saving for that first home can seem daunting for first-time buyers. But it can be done
The Down Payment
Regardless of where you live in Canada or the territories, buying a home is costly, especially for first-time buyers. Because the Bank Act forbids banks from making mortgage loans in excess of 80% of the value of a residential property, anyone wishing to purchase a home must put down at least 20% of the purchase price or appraised value (whichever is less) to qualify for a conventional mortgage from a bank. Given that the national average home price in Canada in July 2013 was $382,373, according to the Canadian Real Estate Association, a first-time buyer of an averagepriced home would have to come up with $76,475 to satisfy a lender providing a conventional mortgage. In addition to the 20% down, most lending institutions have guidelines suggesting purchasers should use no more than 32% of their gross family income for payments of mortgage principal and interest, property taxes and heating; the total debt load (including consumer loans, etc.) should not exceed 40% of the gross family income.
Clearly, first-time home buyers need all the help they can get to maximize the down payment and therefore reduce the principal amount borrowed and the monthly mortgage payments.
Most Down Payments Come from Personal Savings
Sometimes, parents, other relatives or even friends may be a source of a loan or a gift, but for most firsttime buyers, the down payment has to come from personal earnings. Those who have to save funds need a long-term strategy to determine the length of time it will take to save the 20% down payment and the best means of achieving that goal. The following example may provide guidance for those who think saving the "down" is next to impossible. But first, you need to consider how much your first home will cost before you can determine what that 20% amount will be. A local realtor should be able to help you come up with a realistic price range for the type of housing that will suit your needs and means.
How to Save a Down Payment
(The calculations in this article, including those in the accompanying table, are a schematic projection based on the known source deductions and tax rates for 2012.)
Assume the first-time buyer is single, lives in Ontario, is working at their first job, has personal expenses (for example, rent, clothing, food, car payments, etc.) of approximately $20,000 per year and a reported 2012 income of $40,000, which is likely to remain close to that level until 2017. Assume also that the goal is to save $76,475 (20% of $382,373) for a down payment on that average Canadian house and the purchase will be made in 2018. Because the potential buyer is working at their first job, they cannot make a contribution to their RRSP for the first year of employment. The table below shows that the total saved at the end of 2012 is $11,722.
Without RRSP Savings
If the buyer makes no RRSP contributions in any of the following five years, total savings over the six-year period will be only $70,332 ($11,722 x 6 years).
With RRSP Savings
As the chart below shows, contributing to an RRSP provides an additional $7,200 in deferred-tax savings annually for a total RRSP savings of $36,000 for the five years between 2013 and 2017. The after-tax savings for 2012 ($11,722), plus five years of RRSPaffected after-tax savings (5 x $6,157), would total $42,507. The total of RRSP and after-tax savings ($36,000 + $42,507) would be $78,507 by the end of 2017. By making RRSP contributions for five years, the total amount accumulated exceeds the amount accumulated without RRSP contributions by $8,175 ($78,507 - $70,332). In other words, by making annual RRSP contributions, the required down payment of $76,475 can be saved; without RRSP savings, the amount would fall short by $6,143 ($76,475 - $70,332).
The calculations above show that a couple could conceivably contribute as much as $157,014 (2 x $78,507) toward their first purchase, if both persons were in the financial situation described in the table.
$25,000 can be withdrawn from your RRSP as a down payment.
Using the Home Buyers' Plan (HBP)
The HBP allows a first-time buyer to borrow up to $25,000 from their RRSP for use as a down payment. Because only $25,000 of the total RRSP savings of $36,000 can be withdrawn under the HBP, the accumulated savings available is only $67,507 ($42,507 + $25,000). The remaining $8,968 ($76,475 - $67,507) required to make the down payment may also be withdrawn from the RRSP, but it will be subject to income tax in the year withdrawn. If the first-time buyer purchases the home jointly with another firsttime buyer such as a spouse or common-law partner, each party to the purchase is entitled to borrow $25,000 from their individual RRSPs. If, however, either person has owned and occupied a home as a principal residence within the last five years, neither person is considered to be a first-time home buyer and neither is therefore entitled to the HBP.
This $25,000 amount must be repaid to the RRSP over a 15-year period, or an amount equal to 1/15 of the amount borrowed is added to the income of the buyer each year and is subject to taxation. The repayment period starts in the second year following the year in which you made the withdrawal(s).
(Due to space restrictions, the terms of the HBP have been somewhat simplified. Please check the CRA website: http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/ rrsp-reer/hbp-rap/cndtns/frst-eng.html for complete details.)
Naturally, there are other life factors and income tax considerations that may impact the ability to accumulate personal savings, but the example establishes that a savings plan that combines personal savings with RRSP contributions can help you reach your downpayment goal.
Additional Benefits of a High Down Payment
Building an RRSP in conjunction with savings provides positive benefits beyond tax savings:
1. Lenders will see that you are a responsible borrower and a good credit risk for a mortgage.
2. The higher the down payment, the lower the amount of mortgage principal required. Over time, the lower principal requires less interest to be paid on the mortgage.
3. The higher down payment allows faster reduction of the principal amount. Thus, when it is time to renew the mortgage and interest rates have increased, the ability to continue to meet regular payments will be less of an issue.
4. A lower mortgage loan allows "wiggle" room to obtain additional funds in the event of unforeseen expenses that require additional credit.
Seek Advice from a Professional
Anyone thinking about buying their first home should consider spending time with their CPA to discuss their current earnings and map out a strategy that will combine personal savings with tax savings to make that home a reality.
How to Save $76,475 in Six Years
2012*20132014201520162017RRSP SavingsTotal SavingsT4 Income40,00040,00040,00040,00040,000 40,000 RRSP Contribution 07,2007,2007,2007,2007,20036,000 Taxable Income40,00032,80032,80032,80032,80032,800 Source Deductions8,2786,6436,6436,6436,6436,643 After-Tax Income31,72226,15726,15726,15726,15726,157 Cost of Living20,00020,00020,00020,00020,00020,000 Annual Savings11,7226,1576,1576,1576,1576,157 42,507 78,507
*First year of employment, thus no RRSP contribution