Saving for your First Home

Real estateThe average home in Canada currently cost approximately $400,000 and has been climbing steadily for the last decade. Some analysts believe the country is on the verge of a housing market correction which would see increases in house values tapper off or even decline.

To avoid CMHC housing insurance in Canada you need to have a 20% down payment on your house. Mortgage providers typically require a 5% minimum down payment. Depending on the cost of your home this can be a considerable amount. Luckily there a few things you can do to quickly save for a down payment.

RSP Home Buyers Withdrawal

Using the Home Buyers Withdrawal you can use up to $25,000 from your RSP plan on a down payment for your first home. This withdrawal must be paid back into your RSPs within 15 years. There are some stringent rules when you have a spouse or common law partner who has already owned a home, so make sure you read up to ensure you meet the criteria.

Some financial planners will advise against this strategy but I feel the benefit of being able to own a home faster and learning to use such strategies overall outweighs the disadvantage of tapping your savings for a down payment.

Let’s look at a comprehensive example of how an RSP Home Buyers Withdrawal catapults you ahead on a $100,000 house with a 20% down payment of $20,000 saved over two years:

With Home Buyers WithdrawalWithout Home Buyers Withdrawal
Year 1 Savings$10,000$10,000
RSP Refund (20% rate)$2,000$0
Year 2 Savings$10,000$1000
RSP Refund (20% rate)$2,000$0
Total Savings$24,000$20,000

 

This $24,000 RSP withdrawal must be paid back into your RSPs within 15 years, and you are not able to deduct contributed, but there’s an extra $4,000 to use towards a house investment and lower interest via a lower mortgage.

The argument to using the RSP Homebuyers Withdrawal is a loss on investment time and typically salaries of first time home buyers are at their lowest point, which reduces the benefit of the RSP contribution deduction. A comprehensive review should be considered in each situation to determine if the First Time Home Buyers Withdrawal is your best route.

Planning & Tracking

This may seem unimportant as far as actual dollar contributions to your down payment, but it really is the cornerstone to any financial goal. So do it!

Before you determine how much you should save for your first home you should look at how big of a mortgage you can afford. Do to this look at your total income each month. I typically consider housing costs such as mortgage payments, property taxes, utilities and condo fees of 33% of your pre-tax income a safe rule of thumb (i.e. if you had income of $1,000 per month your monthly housing expenses should not exceed $333). From there use a mortgage calculator to estimate the size of mortgage you can carry (https://www.cibc.com/ca/mortgages/calculator/mortgage-payment.html). You will have to estimate the interest rate (5% is appropriate for now) and term of the mortgage.

The cost of the home less the mortgage you can afford is the down payment amount you will need to save. (HOME COST – MORTGAGE AMOUNT = DOWN PAYMENT REQUIRED)

Let’s look at an example at a couple looking to buy their first home for $225,000 in two years. Here’s the run down:

  • Combined annual salary of $80,000 ($6,667 per month)
  • Housing monthly budget of $2,222 ($6,667 x 33%)
  • Monthly utilities, property taxes, repairs and maintenance estimate of $1,000
  • Mortgage payment $1,222 ($2,222 housing budget – $1,000 monthly maintenance)
  • Mortgage rate of 4.99%
  • Mortgage term of 20 years

Based on the above figures our couple could afford a $190,000 mortgage, which result in mortgage payments of approximately $1,248 per month. Therefore, they would need to save $35,000 ($225,000 home cost – $190,000 mortgage).

This $35,000 down payment should be broken down into monthly requires to allow for tracking. If the couple wanted the house in two years they would need to save approximately $1,500 per month ($35,000/24 months). It’s exciting to see the savings balance start to add up each month and will help keep you engaged and motivated throughout the savings period.

Mortgage

When deciding on which mortgage is right for you it makes sense to look at the options out there and there are tons. The two main decisions are the length of the mortgage (term) and the interest rate (variable VS fixed).

The maximum mortgage term in Canada is 25 years. This means you will pay off the entire mortgage in 25 years. The benefit of a longer mortgage is it lowers your monthly payments, however, over the course of the mortgage you will pay more in interest costs using a longer term. An optimal balance between monthly affordability and lower interest payments should be determined.

A variable rate mortgage means your interest rate will change in accordance with a posted rate, typically prime rate. The prime rate in Canada is managed by the Bank of Canada and at the time of this post is crazily low at 3%. Variable mortgages often are posted as prime plus or minus a certain amount. (i.e. prime plus 1% = 3% + 1%).

A fixed rate is one where there is no change in the interest rate on your mortgage for the defined term. Banks and other mortgage providers typically put a time limit on the period they will offer a fixed rate usually around five years. After the five years is up the rate will be renewed.

The benefit of a fixed rate is you know exactly the monthly payments you will be required to pay. For those who are risk adverse and will sleep better in your new home knowing your payments won’t change, this is the way to go. Variable rates can result in lower mortgage and interest payments, but it can also backfire and increase payments.

When I bought my first home I used a mortgage broker and it was a great decision. The broker walked me through this information to help me determine which path was best for me. A broker will also shop around to different bank and mortgage providers to ensure you receive a competitive mortgage.

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