Plan your down payment

Getting your first home is a rite of passage, but first you have to build up your down payment. Bruce Sellery shares his thoughts on the best way to save.

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Question

I’m a new grad who recently entered the corporate world. I’d like to create an investment portfolio once my small student loan is fully paid off. I’m looking for the best way to save for a down payment on a condo. It appears to me that using the RRSP Home Buyers’ Plan to withdraw money when the time is right makes the most sense, but I’m looking for some advice. I’m also looking for what should be used within the RRSP to minimize the fee ratio given my small initial investment.

Answer

Home ownership is a rite of passage, filled with perks and perils. But you are right to start saving for this goal as early as possible. You are also right to consider the Home Buyers’ Plan, though I think you’re going to need a Tax Free Savings Account as well. Here are some things for you to think about.

Hello to the “Home Buyers’ Plan”

The Home Buyers’ Plan allows first timers to borrow money from their RRSP and put it towards the down payment on a house. The amount is capped at $25,000 and you have to repay it slowly over the next 15 years, otherwise it will be treated as income and you’ll have to pay tax on it.

I like the HBP for a few reasons:

Tax refund: The HBP allows you to take advantage of the RRSP tax deferral, so your tax refund is higher each spring and you can save more.

Simplicity: You can focus on putting as much as you possibly can into one place—your RRSP— instead of splitting savings between your RRSP for retirement and a TFSA for your down payment. There are limits as to what you can contribute to your RRSP every year, but most people aren’t near that threshold, especially early in their career.

Discipline: You don’t need as much discipline if you go the HBP route because the money is harder to touch than if it is in a TFSA. Temptations like a trip to Vegas or a new car will be easier to resist because the money is safely locked away in your RRSP. The downside, though, is that you’ll need discipline to pay your RRSP back once you buy your house—and that won’t be easy to do when you have plumbers, roofers and Home Depot sales associates competing for every spare dollar.

Aloha to the “Tax Free Savings Account”

The HBP tops out at $25,000 and you’ll likely need more than that to buy your first condo. Say you have your eye on something that costs $300,000. That sum that is ludicrously high in Zurich, Ont., a small town of about 700 an hour or so drive north east of Sarnia, and preposterously low in Vancouver, a city of two million stressed out, over-extended homeowners. But let’s say you want to save 20%, or $60,000, for a reasonable down payment. The first $25,000 could come from your RRSP, but the remaining $35,000 would need to come from somewhere else, ideally a TFSA.

Break the goal down into bites

While you can buy a condo with less than 20% down, it will be more expensive to go that route given the insurance you’ll need and the extra interest you’ll pay. For simple math we’ll ignore the interest you might receive on your investments. To get the 20% down payment in our example you’d need to save $1,000 per month for 60 months, or 5 years, to reach your goal. Compound interest can help you get there a little sooner, but this is a good way to look at how much you need to save to reach your goal

You can figure out this number for yourself, based on what your income and expenses are, and how much you think you’ll need to pay for a condo. Then break down the big down payment goal into small monthly bites that feel achievable.

Set your savings to autopilot

I was young once, and I know some of the temptations you will face. When I was in school everyone was buying cheap shots and draft beer. But once I arrived in the working world my peers were drawn to costlier cocktails and Harry Rosen ties to spill them on. That is called lifestyle inflation and it is a scourge on responsible spending.

I highly recommend you set your RRSP savings to autopilot and use your credit card sparingly, especially on nights out. Set up a pre-authorized cash contribution from your bank account to your RRSP every payday. And every year on your birthday, revise the amount upwards to account for any raises you’ve received at work.

Buy boring investments and go to exciting movies

You also asked about what sort of investments you should put this money into to minimize fees. If this money really is for a down payment you’ll need in five years or so, most of it should go into a high interest savings account, a guaranteed investment certificate or perhaps a fixed income exchange traded fund. That’s because you don’t want to take the risks associated with the stock market, given your relatively short time horizon. All of those options have low fees, so you don’t have to worry about choosing a low fee mutual fund, for example.

Hit the Open Houses and enjoy the process

Some people really enjoy Open Houses, and if you’re one of them, happy tromping to you. Owning a home is a big goal, but it will happen and is certainly well worth the wait.

ask@moneysense.ca

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