It’s a challenge for a first time home buyer to come up with a down payment. With soaring Canadian real estate prices, crippling student loan debt, and low starting salaries, it can take a long time to save the required minimum down payment.
Canadians do have some options to help them buy their first home. This post will explain the benefits of a first time home buyer using the Home Buyers Plan (HBP) or TFSA for a down payment.
First Time Home Buyer: Using the HBP
The Home Buyers Plan allows you to withdraw up to $25,000 as a loan from your RRSP without paying tax. Under the HBP, only a first time home buyer is eligible to participate, unless special rules for persons with disabilities apply.
You are considered a first time home buyer if neither you nor your spouse owned a home during the four calendar years prior to the year of withdrawal, and up to 30 days before the withdrawal.
Loan repayment under the HBP must take place over a period of 15 years, or less if desired. The repayments begin in the second year following the year of the withdrawal. If the required repayment is not made, an amount will have to be included as income in the year of the shortfall.
If you have previously participated in the HBP, there are certain situations in which you may be able to participate a second time. First of all, the full amount previously withdrawn must be paid back into your RRSP before the beginning of the year that you want to participate a second time. Also, you must still qualify as a first time home buyer.
If you contribute an amount to your RRSP, you can’t make a withdrawal under the HBP within 90 days of that contribution, or your ability to claim a deduction for the contribution may be restricted.
As a general rule, you should make your RRSP contribution more than 90 days before the withdrawal. After a waiting period of 90 days or more, your deduction may generate a tax refund, which can also be applied toward your down payment.
As a first time home buyer, if you have money on hand for a down payment and have accumulated some RRSP contribution room, consider opening an RRSP. You can deposit that money, wait 90 days, be eligible to participate in the HBP, and at the same time use your tax refund to add to your original down payment amount.
Each spouse or common-law partner can withdraw eligible amounts from their RRSPs under the HBP. This also means that each person may withdraw up to the $25,000 limit, or $50,000 total (if purchasing the property jointly).
First Time Home Buyer: The TFSA Solution
The TFSA is a registered plan like the RRSP, but differs from the RRSP because contributions to the TFSA are not tax deductible. The flip side is that withdrawals from the TFSA are not taxable, and that includes any gains earned in the plan.
The TFSA is ideal for saving up for a down payment for a house, and can even be a better solution than the HBP for a first time home buyer.
Unlike an RRSP, you don’t need earned income to create room for the contribution – everyone gets $5,000 per year starting at 18. For example, a 22-year old new graduate with a starting salary of $40,000 will only create $7,200 in RRSP contribution room for next year. With the TFSA, he already has $20,000 in contribution room by 2012 ($40,000 when combined with a spouse).
The other issue with the HBP is that when you first start out in the job market, your income is likely to be low. Since you’re in a lower tax bracket, your RRSP contributions will result in a lower tax refund.
Final Thoughts
The Home Buyers Plan is a good option for a first time home buyer if they have already invested in RRSPs and don’t have any savings outside of their RRSPs. You can withdraw up to $25,000 ($50,000 when combined with a spouse) tax-free, and repay the amount over 15 years.
For young Canadians just entering the workforce without any savings inside their RRSP, it makes sense to use the TFSA from the beginning to save for a down payment on a house. The TFSA offers a more flexible solution for the first time home buyer.
One item of note, you can’t get a loan to contribute to your TFSA. It may have more room for contribution, but unless that 22 year old lives at home still, they aren’t going to be saving 50% of their gross pay very easily.
However, a loan to get the RRSPs started, using the return to pay down the loan a nest egg to use as a down payment is created.
Hi Randy, that’s a good point. However, you still have the same RRSP contribution room, whether you take out a loan or not. Also, the tax refund usually doesn’t come close to paying off the RRSP loan in full, so now you have to come up with extra money each month to pay that down.
Also very valid points, but the underlying point with both ideas is that each case will be different based on the situation and future goals of the individual.
A serious cause of concern for all first time homebuyers right now should be that the banks are targeting stricter limits on mortgages, while allowing unsecured consumer debt to grow. The fallout for that could be a larger down payment being required, somewhere in the 7.5 to 10% range. I believe that would have an extremely staggering negative impact on housing prices in Canada by taking a significant segment of the population out of the market, and causing a loss of equity for those already having purchased. The Globe reported on this with a very negative slant, http://ow.ly/963F3.
I used both!
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It should be noted that there can be huge penalties to withdraw RRSPs for the Home Buyers Plan. This was very disappointing. There is no incentive to repay our bank the RRSPs we withdrew. We assumed that the HBP would have mentioned this little fact.