Video #3 – Using Your RRSP’s for Your Down Payment.
One great source of funding for your mortgage down payment is a Registered Retirement Savings Plan (RRSP). The Canadian Government’s Home Buyers’ Plan (HBP) allows you to borrow up to $25,000.00 from your RRSP for a down payment, tax-free. However, since the HBP is considered a loan, it must be repaid within 15 years.
To learn more about the eligibility requirements and repayment term, watch the video below.
First-Time Homebuyer Eligibility
In order to be eligible as a first-time homebuyer, you must meet the following criteria:
- Not owned a home within the previous four years
- Sign a written agreement to buy a home
- Intend to live in the home within one year of purchase
- If you have used the Home Buyers’ Plan before, you cannot have any outstanding balance due
- You must make the withdrawl from your RRSP within 30 days of taking title of the home
- You must buy the home before October 1st of the year after you made the withdrawal
If you are buying with a partner, each spouse needs to qualify as a first-time homebuyer, in order for you both to withdraw from your individual RRSPs. For example, if you have owned a home in the last four years but your spouse has not, then your spouse would be able to withdraw money from their RRSP under the Home Buyers’ Plan, provided you and your spouse have not been living together in the home you owned.
If you make a withdrawal from your RRSP, but do not meet the first-time homebuyer eligibility requirements, this withdrawal will be taxed and you must include it in your income tax statement as taxable income. If both you and your spouse meet the first-time homebuyer eligibility requirements, each of you can withdraw up to $25,000 from your RRSPs for a total of $50,000.
In order to participate in the Home Buyers’ Plan, you must print off a copy of Form T1036. This form is available from Canada Revenue Agency’s website (www.cra-arc.gc.ca). You must fill out Section 1 then give the form to the financial institution that holds your RRSP so they can fill out Section 2. Your financial institution will send you a T4RSP form, which will confirm how much you withdrew from your RRSP as a part of the Home Buyers’ Plan. You must reference this form in your income tax return for the year you made the withdrawal.
Repaying the Home Buyers’ Plan
Since the Home Buyers’ Plan is considered a loan, you must repay the amount you withdrew from your RRSP within 15 years, with the first payment due two years after you first withdrew the money. Canada Revenue Agency will send you a Notice of Assessment, which will indicate the amount of the loan you have repaid, the balance left to be repaid, and the amount of your next payment. To start repaying the loan, you must make a contribution to your RRSP in the year the repayment is due or in the first 60 days of the following year.
Holding Your Mortgage in Your RRSP
Though not commonly done, you do have the option to hold your mortgage within your RRSP. This is only possible, however, if you have built enough cash or cash equivalents in your RRSP to cover the entire mortgage amount. Your RRSP essentially becomes the bank or lender, loaning you the funds required to purchase your home in exchange for regular interest and principal payments.
To understand how this works, we will look at an example where Mitch is purchasing a $400,000 home, with a down payment of 20%:
|Step 1: Down payment comes from personal savings:||$400,000 * 20% = $80,000|
|Step 2: Remaining balance is borrowed from RRSP:||$400,000 – $80,000 = $320,000|
|Step 3: Amounts are combined and given to seller:||$400,000 is given to seller|
|Step 4: Mitch sets his interest rate to the market rate:||For this example we’ll use 4%|
|Step 5: Mitch sets his amortization period:||For this example we’ll use 25 years|
|Step 6: Calculate the monthly payment:||Monthly payment = $1,683.27|
|Step 7: Monthly payment into RRSP over next 25 years:||$1,683.27 * 12 months * 25 years = $504,981|
Over the next 25 years, Mitch will pay $1,683.27 into his RRSP each month. At the end of the 25 years he will have paid a total of $504,981 with $320,000 to cover the mortgage principal and $184,981 in interest payments.
The interest portion of this amount is tax-free because it is held within his RRSP, and the rate of return on the $320,000 from Mitch’s RRSP will be 4% over the 25-year period.
Advantages of Holding Your Mortgage in Your RRSP
The advantage of holding your mortgage in your RRSP is that it has a safe and reliable rate of return. It is essential to compare this rate of return against the cost of investing your RRSP into other assets. Some individuals also like the fact that they are paying themselves interest instead of the bank.
Disadvantages of Holding Your Mortgage in Your RRSP
It is also important to consider the disadvantages associated with this strategy. First of all, you must be prepared to pay the administration fees, such as setup fees, trustee/mortgage administration fees, RRSP fees and legal fees, which can reach upwards of $1,000.
Secondly, you must obtain mortgage default insurance from CMHC regardless of the size of your down payment. With traditional mortgages, homebuyers are only required to take out mortgage default insurance if their down payment is less than 20%. If you hold your mortgage in your RRSP, however, you must purchase CMHC insurance even if your down payment is 20% or higher. CMHC insurance is calculated as a percent of your mortgage amount as follows:
|Amortization Period||Down Payment (% of Home Price)|
|5-9.99%||10-14.99%||15-19.99%||20-24.99%||25-34.99%||35 or higher%|
|25 years or less||2.75%||2.00%||1.75%||1.00%||0.65%||0.50%|
Finally, if your entire RRSP amount has been used to hold your mortgage, you are committing your entire portfolio to a fixed income rate of return.