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RRSPs and Your Down Payment

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rrsp down payment adviceAs is reported in the news at least once a month, there doesn’t seem to be an end or a limit to the ongoing rise in Canadian house prices. While the cost of housing in Vancouver and Toronto outstrips prices everywhere else, even smaller markets are posting record increases.

As with just about any economic development, there are winners and losers in this scenario. Baby boomers (and the parents of baby boomers) who purchased a home decades ago and are now looking to sell will undoubtedly realize a significant tax-free gain on that sale. The biggest losers are those who are still on the outside looking in—generally younger Canadians who are trying to break into the housing market by acquiring that first property, whether it’s a condo, townhouse, or detached home.

For most individuals or families in the market, buying real estate is a significant long-term financial commitment and right now, that financial commitment can be assumed at record low interest rates. As of the end of September, a five-year fixed-rate mortgage (the kind of mortgage taken out by two thirds of home buyers aged 18 to 34) could be obtained from major Canadian financial institutions at an interest rate of less than 3%. For most of those looking to get into the market then, the biggest hurdle isn’t likely the ongoing cost of financing, but the need to put together the required down payment. A down payment is calculated as a percentage of the purchase price of the house and so, as house prices in most Canadian markets have increased, the amount of the required down payment has risen in tandem. And, if that weren’t enough, changes made to the rules governing the financing of home ownership over the past few years have set the bar even higher.

Until the summer of 2008, it was possible to buy a home in Canada with a zero down payment (in other words, the entire cost of the home was borrowed) and to amortize repayment of that cost over up to 40 years—a time frame which would put most purchasers past the traditional retirement age of 65 by the time the mortgage was paid off. Successive changes implemented by the federal government have whittled away at those practices. Borrowers are now required to have at least a 5% down payment on a residential home purchase, and the maximum amortization period on a residential mortgage is 25 years. More stringent borrowing requirements are also imposed on would-be home purchasers, in terms of the percentage of income which monthly costs related to housing (mortgage payments, property taxes, and home heating) are permitted to consume.  

All of this leaves the would-be first time home purchaser falling further and further behind when it comes to putting together a sufficient down payment. There is, however, another option available to that first-time purchaser, and it’s one not just sanctioned but created by the federal government itself. That option is borrowing all or part of the down payment from one’s registered retirement savings plan (RRSP), on a tax and interest free basis, under a program known as the Home Buyers’ Plan (HBP).

The average house price in the Okanagan right now is about $340,000. The rules governing the HBP permit each taxpayer to withdraw up to $25,000 from his or her RRSP, which would be enough to make a 7% down payment on the average home. And, if there is a silver lining to the fact that many Canadians are forced to defer their entry into the housing market, it may be that, having been in the work force for a longer period of time, they are more likely to have at least $25,000 in their RRSPs. And, as outlined below, married couples can aggregate funds from each of their RRSPs to come up with that down payment.

While the rules governing HBPs can be detailed in their application, especially when it comes to any special circumstances or any contravention of those rules, the concept of the program is straightforward. A first-time home buyer who has entered into an agreement to purchase or build a home can withdraw up to $25,000 from his or her RRSP to purchase that home. The amount withdrawn is not taxed on withdrawal, as it usually would be, but must be repaid to the RRSP, without interest, over the subsequent 15 years, with the amount of each annual repayment prescribed by law. Where the first-time home buyer is married, and his or her spouse is also a first-time home buyer, the spouse can also withdraw up to $25,000 from his or her RRSP and both withdrawals can be pooled to come up with a down payment.

There are some additional rules, as follows. The home purchased using funds borrowed under the HBP must be bought or built before October 1 of the year following the year of withdrawal. As well, the borrower (and his or her spouse, where applicable) must intend to occupy the home as the principal place of residence within one year after its purchase—the HBP is not intended to provide funds to purchase or build rental residential accommodation.

The concept of a “first-time home buyer”, while seemingly self-explanatory, is in fact more flexible than it first appears. For purposes of the HBP, a first-time home buyer can actually be someone who has previously owned and lived in a home, as long as that home ownership ended more than four full calendar years prior to the time a withdrawal under the HBP is made. For instance, an individual who wishes to participate in the HBP by making a withdrawal of funds on March 31, 2016 will be considered a first-time home buyer if he or she had not owned and occupied a home after the end of 2011, the four full calendar years being the period between January 1, 2012 to February 29, 2016. Where the prospective home owner is married (including a common-law partnership), the same requirement applies to that person’s spouse.

Whatever the amount withdrawn from the RRSP under the HBP, that amount must be repaid within a maximum of 15 years. The first repayment is required in the second year following the year of withdrawal so, in the case of the example above, where the withdrawal is made in 2016, the first repayment must be made in 2018. Each repayment is generally 1/15thof the amount withdrawn so, a maximum withdrawal of $25,000 would mean an annual repayment amount of $1666.66. The taxpayer doesn’t have to keep track of where he or she stands with respect to the repayment schedule—each year, a Statement of Account sent to the taxpayer with his or her Notice of Assessment, after the annual return is filed. That Statement will summarize amounts repaid to date, the current HBP balance, and the amount of the next repayment which must be made. Such repayments are made by making a contribution to the taxpayer’s RRSP during or within 60 days after the end of the year for which the repayment is due, and designating part or all of that contribution as an HBP repayment on Schedule 7, which is then filed with the tax return for that year. If the taxpayer does not make the repayment when and in the amount required, any outstanding amount is added to income for the year and taxed at the taxpayer’s top marginal rate. 

Like all investment and tax planning strategies, borrowing money from your RRSP to put together a down payment on a first home has both upsides and potential downsides. The biggest downside is the permanent loss of investment gains on the money temporarily withdrawn from the RRSP during that period of withdrawal. However, it’s also possible that the real estate purchased with the withdrawn funds will enjoy a greater increase in value over that period than would have earned by the funds had they remained in the RRSP. Like all investment and tax planning decisions, it comes down to a personal decision based on one’s own circumstances.

The rules outlined above summarize the basic structure and operation of the Home Buyers’ Plan. However, anyone contemplating making use of the HBP will need to familiarize themselves with those rules in much greater detail, perhaps with the assistance of professional advisers. A good place to start is the Canada Revenue Agency website, where information on the HBP can be found at www.cra-arc.gc.ca/tx/ndvdls/tpcs/rrsp-reer/hbp-rap/menu-eng.html.

The information presented is only of a general nature, may omit many details and special rules, is current only as of its published date, and accordingly cannot be regarded as legal or tax advice. Please contact our office for more information on this subject and how it pertains to your specific tax or financial situation.