The Federal Home Buyer's Plan allows first time home buyers to withdraw up to $20,000 from their RRSP for the purpose of buying or building a qualifying home. The primary benefits are that the RRSP issuer will not withhold tax on the amount nor will you have to claim the amount as income. The amount must be repaid to the RRSP within 15 years with a minimum annual payment of 1/15th of the amount withdrawn. If a repayment is not made for a given year the minimum repayment is included as taxable income for that year.
To participate you have to withdraw the amount from your RRSP using form T1036 Applying To Withdraw An Amount Under the Home Buyers Plan. Give the completed form to the RRSP issuer along with the certification that you meet or intend to meet certain conditions as follows:
- You have to make your withdrawal request in the same year you wish to participate in the Home Buyers Plan
- You cannot have previously participated in the plan in previous years
- You have to be a resident of Canada
- You have to enter into a written agreement to buy or build a qualifying home. You can withdraw a total of $20,000. Multiple withdrawals are allowed. Each of you and your spouse can participate in the Plan and withdraw $20,000 from your own RRSP's
- You have to be considered a First Time Home Buyer.
A qualifying home is a housing unit located in Canada. Existing homes and homes under construction are both qualifying homes and can be either:
- Single Detached Family Homes
- Semi Detached
- Town Home
- Mobile Home
- Condominium Unit
- Apartment in a Duplex, Triplex, Quadraplex or apartment building
- A Share in a Cooperative Housing Corporation, provided the share entitles you to possess, and gives an equity stake in a housing unit.
- First Time Home Buyer
You are considered a first time home buyer if you have not owned a home while you occupied it as your principal place of residence for five years. At any time in the fifth calendar year since you last owned a home you can qualify.
The 1998 budget now allows Canadians to use the home buyers plan again. The applicant must have no outstanding balance on any previous Home Buyers Plan loans and must re-qualify for the program again. This means the home owner must re-qualify as a first time home buyer by not owning for the prescribed period. The effective date of the changes is 1999.
Should You Take Money Out of Your RRSP for A Home Purchase
Withdrawing $20,000 from your RRSP under the "Home Buyer's Plan" can be viewed as a loan from your RRSP to yourself. Some call this a zero interest loan but of course the actual cost of the loan is exactly what the funds would have earned if they had remained in your RRSP. You will forego these earnings if you take the funds out and use them for a down payment. On the other hand if you don't withdraw these funds you will be forced to borrow the required down payment.
Let's assume you have $20,000 in your RRSP at an average annual rate of return over the next 15 years of, say 8%. In 15 years your $20,000 will have grown to $63,443 an increase of $43,443. As such if you withdraw these funds under the Home Buyers Plan, while you won't suffer taxes. you will forego these earnings.
Most financial advisors will counsel you to borrow to invest in your RRSP because the "overall" rate of return from your RRSP is greater than the cost borrowing $20,000 in a catch up loan over 15 years is usually in the neighbourhood of Prime, plus or minus a percentage point, depending on the risk of the RRSP investment. Assume a cost of 7.5% over the 15 year amortization of the loan. The interest paid to borrow $20,000 would be $13,372. If we also assume a 35% tax rate, you would have to earn $20,572 of gross income in order to net out these interest costs.
We can now compare the before tax cost of borrowing around $20,572 - with the before tax return this $20,000 would earn in your RRSP - around $43,443. Clearly it makes sense to borrow to invest in your RRSP. Conversely, it should also make sense to leave the money in your RRSP and borrow your down payment, one being the same as the other.
In reality, no mortgage lender will finance 100% of your purchase price. In addition, your lender will qualify you for a larger mortgage, based on gross income, if your debts are lower and don't include a large personal loan or a second mortgage is a debt that squeezes the maximum mortgage amount you will qualify for if it puts you above the lenders target debt service ratios.
In addition withdrawal under the Home Buyers Plan may be more cost effective than borrowing if this borrowing cost also includes a CMHC fee. This fee can dramatically push up your effective interest rate. If you're just shy of a conventional down payment of 25% it may be wise to withdraw the remainder from your RRSP to avoid paying mortgage insurance fees.
The best approach is to withdraw from your RRSP under the Home Buyers Plan, get all the financing you qualify for, and then once the mortgage is funded borrow to replenish the RRSP if you can afford the payments. Remember you'll also have to pay back your RRSP 1/15th each year.
Pay back the minimum 1/15th required each year if you borrow through the Home Buyers Plan. Repayments do not trigger another tax savings. All savings above the minimum 1/15th repayment should be designated 'contributions' rather than the repayments, and invested into your RRSP. You'll receive the tax savings on these amounts each year.
Always invest as much as you can in your RRSP, even if you have to borrow, but be sure you can afford to carry the loan.
Withdraw money from your RRSP only if you have no other source of non RRSP savings.