Home buyers: how much should your down payment be?

It is difficult to calculate whether using the HBP is beneficial or not. A home buyer who uses it loses tax-deferred growth in their RRSP; how much depends on the return that their investments could have generated otherwise. Withdrawals from an RRSP are potentially taxable upon withdrawal, no later than age 72, and future tax consequences can be difficult to determine. If a HBP withdrawal allows a buyer to move into their own home or reduce or avoid CMHC insurance premiums, it may be worth considering a withdrawal.

Should you withdraw money from your TFSA to buy a house?

If a homebuyer has a Tax-Free Savings Account (TFSA), the decision to use the TFSA to make a larger down payment depends in part on the expected return on the TFSA. Over the long term, the stock market can return 6-7% before fees. If someone pays a 1-2% investment fee, a portfolio of just stocks can generate 4-6% per year. If an investor is cautious and holds cash, bonds, or other fixed income investments, their return expectations may be lower. Consider that current mortgage rates are around 2%; some cautious investors may not earn much more than 2%, which is probably worth it for them to spend their TFSA funds on buying a home. However, as interest rates rise, the potential to earn more on a TFSA may make staying in the investment account a better deal than spending those funds on a mortgage.

Even though the rate of return is similar to a borrower’s interest rate, a TFSA can also serve as a potential emergency fund.

Use of non-registered investments for your down payment

If a home buyer has unregistered savings, the rate of return required to justify keeping the funds invested instead of making a larger down payment becomes higher. This is because unlike TFSAs, non-registered investments are taxable, with interest, dividends and realized capital gains being reported in the investor’s income tax return. An investor may need to earn a 3-4% return just to break even if their mortgage rate is 2% (depending on their tax rate and type of investment income). As rates rise, so does the required return.

A home buyer with non-registered investments can tip the balance in their favor by making their debt tax deductible: they can use their non-registered savings to make a larger down payment, then borrow to replenish their investment account. . This will usually allow them to deduct interest on borrowed funds used for the investment. Their return required to reach equilibrium can then be comparable to their mortgage rate. But, again, as rates rise, the potential return delta may become smaller. If mortgage rates go up to 4% and their investment returns are 5%, the $ 1,000 profit per $ 100,000 of leverage might not be worth the risk and complexity.

Keep in mind that interest on money borrowed to invest in RRSP or TFSA accounts is not tax deductible — only money used for non-registered investment accounts.

It’s a good thing to pay a large down payment. This means you have a stronger balance sheet, less debt, and less risk when rates rise. You might also be able to avoid CMHC insurance premiums if you put more than 20% down. Keeping the money invested instead of using it for a down payment may or may not help you come out a winner. A priority with any real estate purchase should be making sure you still have room in your budget for emergencies, and most importantly, saving for the future.

Jason Heath is a Fee and Advisory Only Chartered Financial Planner (CFP) with Objective Financial Partners Inc. in Toronto. He does not sell any financial products.

About Matthew R. Dailey

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