Saturday, September 11, 2010

Understanding Your Downpayment Options

Looking to purchase your first home?

Do not have access to your required down payment?

What are your options?

Interest rates are at an all time historic low. Many would-be home purchasers are eager to realize their dream of home ownership, but just can't seem to save the required 5% down payment. And despite an excellent credit and employment record, saving the required money is tough.

It is amazing the number of ads I see that say "you can purchase your first home with no down payment."

Prior to October 15, 2008, this would not have been much of a problem because there used to be a program known as The Zero Down Payment Program, which is no longer available. This program was eliminated by the federal government and required CMHC approval (Canada Mortgage & Housing Corporation).

With the number of ads showing 100% financing, many consumers are still mistaking this as the Zero Down Program, and it is not. If there still were such a program (which there is not), why then would a financial institution offer to provide you with a 5% cash back down payment. Zero down means a true 100% financing, not 95% with an additional 5% as a cash back down payment.

Please understand this — 100% financing as it is often referred to by realtors, mortgage brokers, and lenders, is simply a cash back program that some lenders, not all lenders, offer, and these programs come with some catches:

The interest rate is much higher, usually full bank posted.

If you break your mortgage contract early, you will be re-paying a good portion back as part of your penalty.

It requires impeccable credit.

For example, say your cash back was $10,000, and you broke the mortgage contract with 3 years remaining in the term, because it is pro-rated at 20% per year, you would have to pay back 20% X 3 years which is $6,000, plus any additional penalties and applicable fees.

In addition, there may be a CMHC surcharge on top of the normal CMHC fee. There are two forms of cash back. The first is called the 5% Cash Back Down Payment, and the second is known as the 5% Cash back.

So, let's discuss your options, but before we do, it is always in your best interest if you have access to your own down payment because you will get a much lower rate of interest.

Option 1. Using Your RRSP

Should you use your RRSP to buy a home? If you're looking to purchase or build a home, your Registered Retirement Savings Plan (RRSP) may hold the key to affording that dream home.

Under the Home Buyer's Plan (HBP), prospective home buyers can borrow up to a maximum of $25,000 tax free from their RRSPs. If their spouse/partner also contributes to an RRSP then both may draw up to $25,000 each from their RRSPs.

To be eligible for the RRSP HBP you have to be first time home buyers, or have not owned your principle residence at any time during the year of your RRSP withdrawal and the four preceding years. If you have already purchased a home, you have up to one month after the purchase to still apply to the HBP. And you must be a Canadian resident to be eligible.

RRSP Repayment Rules

Repayment begins the second year following the year in which you made your withdrawal. You have up to 15 years to repay the full amount where each year 1/15 of the total amount is due. Canada Revenue Agency (CRA) will send you statements outlining your repayment schedule.

HBP Advantages

The HBP affords you a tax free and interest free way to access the money in your RRSP, allowing you to buy a home sooner. If you can use your RRSP under the HBP to make your required down payment, then you may qualify for a lower rate of interest on your mortgage and may avoid paying a higher CMHC fee or eliminating the CMHC fee if your down payment is 20% or greater.

HBP Disadvantage

While the HBP gives you a way to realize your dream of home ownership sooner, you should be aware of the downsides of missing a repayment and accessing your RRSP savings before retirement.

Missing Repayments

If you don't make a full payment in a year, the unpaid amount is fully taxable as income in your hands.

Loss Of Tax Free Growth

Borrowing money from your RRSP means you're losing out on up to 15 years of tax free growth, which may not be made up by the increase in home equity over time.

Contribution Rules

You cannot make an RRSP contribution and then immediately withdraw that contribution under the HBP — you must wait at least 90 days.

Declaring Bankruptcy

If you declare bankruptcy, you still need to make the payments back to your RRSP, or the money will be taxed as income in the years you don't make a payment.

Taking Out An RRSP Loan

This is an excellent option, especially when it comes to tax time. You apply for an RRSP loan, which will increase your tax refund, and coupled with the HBP withdrawal, you can increase your down payment. The draw back is in addition to having to make repayments on the HBP, although you have 15 years to do so, you will have to include the RRSP loan payments as part of your debt servicing. As long as you can service this debt, you should be okay. Remember, you cannot make the RRSP contribution withdrawal for a minimum of 90 days.

Check out the Home Buyer's Plan details at the Canada Revenue Agency website at Should you decide to go this route, we have the HBP forms here and can assist with in filling them out.

Option 2. The 5% Cash Back Down Payment

These programs allow you to borrow 95% of the value of the purchase price of your new home. The participating lender then provides you with a 5% Cash Back Down Payment and is based on a 5 year fixed term — not on a variable or adjustable rate mortgage. This cash back can only be used as your down payment.You are still required to show that you have at least 1.5% of the purchase price to cover closing costs.

The down side being of course the higher rate of interest and pay back for early termination of the contract should you decide to terminate your mortgage contract before the standard term matures.

Option 3. The 5% Cash back Program

Similar to the 5% cash Back Down Payment, but not the same. In this program, the cash back cannot be used as your 5% down payment. It is a simple cash back for whatever reason you choose to use it, such as buying furniture, etc. You still need to show that you have the required 5% down payment and your closing costs.

One way to do this is to get a financial gift or loan from a family member, and on your day of closing, you return the money from your cash back. The same down side applies as Option 2.

Option 4. Government Grants

From time to time, municipalities may receive federal grants for first time buyers under what is known as the Canada Ontario Home Owner Assistance Program. If and when such grants are available, you have to qualify and there are certain terms attached to the grant. Grants can range from 5% to 10% as your down Payment.

Option 5. Access Available Credit

Using your line of credit, credit card or getting a personal loan is an option but you will have to show your monthly payments to debt service the mortgage. A line of credit is the better way to go as you may only have to make interest payments which will greatly reduce your monthly line of credit payment.

Option 6. Convert Assets to Cash

Sell off unwanted or unused assets, be it a boat, camper, vehicle etc. In doing so, make sure you have a true copy of the bill of sale and make a copy of the cheque(s) you receive or if it is a cash sale, a bill of receipt and show that exact amount being deposited into your bank account.

Option 7.


No comments: