What is the best way to save for a down payment?
When tapping into savings to buy a home, it’s important to know all your options
Chris Villegas-Cho and his partner knew they couldn’t rent their one-bedroom apartment in Toronto forever.
The pair wanted more space for themselves and visitors, and decided to look for a bigger home. But this time, they decided they would own instead of rent.
“I did the math (and) … the rental price for the equivalent unit was more or less the same,” said Villegas-Cho.
So he and his partner sat down and tallied how much they had in savings, how much they would need, and how large a mortgage they could afford, taking into account as well the tax credits they could get as first-time homebuyers.
“We got to see how much we were each pre-approved for individually, and then both as a couple,” he said.
For his part of the down payment, Villegas-Cho used savings from his taxfree savings account (TFSA), but it wasn’t quite enough, so he dipped into his registered retirement savings plan (RRSP). The Home Buyers’ Plan allows people to do this, but you have to pay the funds back into your account within 15 years, which made Villegas-Cho reluctant to use too much from his RRSP.
“I think I was a bit more hesitant just on the basis that I would need to commit to repaying,” he said.
He also didn’t want to use up all his savings: “We wanted to give ourselves a little bit of buffer room.”
It took six months, but Villegas-Cho and his partner found a condo in 2019 that fit all their needs, though the second bedroom came in handy not for visitors, but for working from home after the pandemic hit.
“At the end of the day, with each mortgage payment, we’re also paying a bit of the principal down on the home, so a little bit of that money is coming back to us at the end.”
Your down payment can come from a number of different places, if you don’t have a dedicated savings vehicle for it already. Like Villegas-Cho, you may need to dip into more than one account to pull together the down payment.
Here are some of the best options for boosting your down payment, and which options to avoid.
Janet Gray, an Ottawa-based certified financial planner with national firm Money Coaches Canada, said first-time home buyers are often under pressure to come up with a big down payment, whether it’s to win a bidding war or take on a smaller mortgage.
“Down payments are tricky,” said Gray.
Many people don’t have the resources to come up with 20 per cent, she said.
It’s a good idea to get pre-approved for a mortgage before you start shopping, Gray said, so you don’t wind up disappointed if you fall in love with a home outside your budget.
When calculating what down payment you can afford, remember that the mortgage is just one part of the cost of buying a house, said Gray. Always be conservative in your estimates and leave financial room for the unexpected.
Gray said she recommends people
“I think if somebody needs to borrow money from an alternative lender … my question is, can you afford to buy a home?”
JASON HEATH
OBJECTIVE FINANCIAL PARTNERS
turn to their TFSA first for the down payment, rather than the RRSP. That’s because there are no strings attached to the TFSA funds, which are also tax-free, while the RRSP funds must be paid back into the account.
It’s kind of like owing money to your future self, said Jason Heath, managing director at Objective Financial Partners.
But he said the Home Buyers’ Plan is still a good option, however, especially for a first-time homebuyer with a higher income.
However, the downside is that while a bigger down payment may mean a smaller mortgage, dipping into your RRSP means giving up some tax-deferred growth. “It is a little bit of a tradeoff,” he said.
Often, people will take the “easy route,” said Gray, taking out the maximum they can from their RRSP under the Home Buyers’ Plan, which is $35,000, and paying it back in over 15 years.
But “they’ve lost some compound
interest for that time period, so that’s not my preference,” said Gray.
“I think, truthfully, if people have to use $35,000 from their RRSPs, they can’t afford a house,” she said.
Some people turn to different kinds of debt when putting together a down payment, such as an alternative lender, borrowing from family or even taking on a second mortgage.
Gray doesn’t generally recommend getting into debt for a down payment, but understands the motivations that
might lead people to do so.
“Sometimes it’s a short-term solution,” she said, to get your foot in the door when the market is good.
Family loans might seem attractive, she said, as they may have little to no interest and flexible repayment plans. But don’t assume your family can’t be destroyed by spats over money, she said — any family can.
If you go this route, you should prepare for the worst. Get a lawyer to look over any official document you sign, just in case.
“It’s not enough to write it on a piece of paper and both sign,” she said.
It’s quite common for people to get family loans for their down payment, said Heath, but he agrees it’s not without risk.
“It won’t affect your credit score, but it might affect whether you get an invite to Thanksgiving,” he said.
But despite the risks, Heath said if you are going to borrow money for some or all of your down payment, borrowing from family is likely a better financial move than another form of debt with higher interest and less flexibility.
“I think if somebody needs to borrow money from an alternative lender … my question is, can you afford to buy a home?” he said.
You can’t count on the rising real estate prices of the past few decades to ensure your investment will prosper, said Heath.
“If that home does not rise in value as much as you thought, it can be really disadvantageous to pay a high rate of interest to buy the home in the first place.”
Gray said though she understands some people looking to buy their first home might be eager to start now and be worried that prices will only rise, it’s best not to jump in until you can truly afford to do so.
“We know that market prices fluctuate,” she said. “We’re already seeing a shift.”
That’s why it’s better to have patience, save up and, hopefully, eventually get more for your money.
When you do make that leap, make a small one; remember, this is your first home, said Gray. It’s better to buy a starter home the first time around.