Why you should avoid the Home Buyers’ Plan
Before you tap into your RRSPs for a down payment, consider the potential downsides.
Here's a rare bit of good news on the household debt front. We Canadians are pulling in our spending horns — just a bit. Our appetite for credit card debt shrunk just over two per cent between April 2011 and April 2012. And Canadians aren't applying for credit as much either. According to Equifax Canada's most recent quarterly consumer credit report, demand for new credit is actually three per cent lower than it was in 2008.
On the other hand, we still intend to reach for credit to finance life's big purchases. For example, the 2012 TD Canada Trust Report on Savings shows that a whopping 61 per cent of Canadians would be comfortable financing a home down payment. Note, we're not talking about a mortgage here but the down payment.
A significant number (57 per cent) would also finance a car, education (54 per cent), starting a family (46 per cent) and their wedding or honeymoon (38 per cent). But none of these stats is as worrisome to me as the one relating to a down payment. To complicate matters, I'm betting that the 61 percent doesn't include those who would take advantage of the first time Home Buyers' Plan, which allows withdrawing up to $20,000 tax free from an RRSP to buy a home.
And by far the majority will use that HBP money for all or part of their down payment. But here's the rub; many don't see this as a loan just like any other. But it is and has to be paid back, granted without interest, within 15 years. If you are among those who buy a first home with an RRSP withdrawal then you are essentially doubling up on debt.
People are usually surprised when I counsel caution over the HBP but here are three solid reasons to avoid tapping your RRSP for a down payment.
1. The payback problem: You have 15 years to replace the money borrowed from your RRSP but you don't have to put in a dime until the last minute. Typically first time buyers have tons of other expenses, from furniture to drapes and other household items — then along come children. Repayment of the HBP loan is often put off for years.
2. The RRSP problem: It's mighty tough for first time homebuyers to handle house expenses, return borrowed funds to their RRSP and keep up with regular RRSP contributions. The smart thing to do with the HBP is to divide the amount withdrawn by the 15-year payback period and ensure you return that amount annually to get rid of the debt. But with so many families on such tight budgets, adding in RRSP contributions could be unaffordable.
Only 16 percent of young adults (21 to 34) contribute the maximum to their RRSPs and I believe a big reason is the popularity of the HBP for this first-time homebuyer age group.
3. The RESP problem: As with RRSP contributions, it can be difficult to deposit funds to a Registered Education Savings Plan for children while paying back money borrowed through the HBP.
RESP contributions attract a 20 per cent government grant on the first $2,500 deposited. That's free money! If children appear early on after buying a first home they could easily be tweens before parents can afford to make significant RESP contributions. At that point, unless you are a high-income earner, catching up to snare those juicy government grants is very difficult.
Having said all this, I just know that a large number of first time buyers will be using their RRSPs for a down payment. Here are two tips to make sure you do it right.
1. Keep it liquid: The money in your RRSP designated for a house purchase must be liquid, i.e. in a cash type holding such as a GIC, not in stocks or equity mutual funds. A dip in the market can send your available funds south for years.
2. Divvy up the payback: On your tax return you can apportion a percentage of your RRSP deposits to HBP payments and the rest as RRSP contributions. Even $50 a month going to retirement savings will help you build a nest egg.
While today's record high real estate prices make the Home Buyers' Plan even more attractive, do consider the negatives before you drain your RRSP for a down payment.
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