First a quick recap of the down payment options available in the market place today. The traditional program is where you save the money over a period of time and then use these savings for the purchase of your new home. The other options are gifted down payment from an immediate family member or using your investments/RRSP towards the purchase of your new home. You can check out the RRSP program by going to the Revenue Canada site here. Other options are selling an asset such as a current home or even a vehicle etc. (Be sure to keep a record of this sale though as the lender will ask for proof of where funds are coming from). Then we have the 0 down program or getting a loan for an RRSP and then after 90 days using these funds to purchase a home and following the same rules as set out by Revenue Canada. (see link above)
You can check out the blog I wrote regarding the 0 down payment program by going here.
So what is the best option? Below is an example of the interest costs you can expect to incur with either option. As you will see it is extremely beneficial to borrow money for an RRSP and then use this money for the purchase of a new home.
We will use a $200,000 purchase as the example using a 5 year term and a 25 year amortization. Under the 0 down program the current interest rate being offered is 5.24% on a 5 year term. There are only a few lenders offering this product so right away your choices become limited. A cash back will be issued at closing by the lender to be used for the down payment. You will still be responsible for all closing costs and will need to prove you have these funds available. This means you are basically locked in for the full 5 years. If you did decide to payoff the mortgage then you will need to be prepared to pay back the 5% cash back plus an additional prepayment penalty. Trust me when I say this will be a costly venture. So lets look at the numbers.
$200,000 purchase less a 5% down payment (in the form of cash back) which equates to $10,000 or net mortgage amount of $190,000. We add the CMHC premium on top of this (we note CMHC premiums are higher for 0 down programs) of 2.9% or $5510 to give us a mortgage amount of $195510.00. This will be the amount you will sign for at the lawyers office. The payment on this amount based on a 5.24% interest rate will be $1163.95 principle and interest. Using this example you are going to pay about $48000.00 in interest based on a monthly payment for 5 years and you will have a balance of about $174000.00 left.
Using the same figures but borrowing the money to purchase an RRSP for $10,000 the figures will change drastically. I had a client recently do this and the rate on the RRSP loan was 6.5% over a 48 month period. The payment based on this would equate to $236.75 per month and the interest for the full 48 months would equate to about $1364. (We note that we have to use the new loan payment to qualify the client for the deal). Now the net mortgage amount again is $190,000 and the CMHC premium is 2.75% or $5225 to give us a mortgage amount of $195225.00. Now using a 5 year current rate of 3.19% the payment based on a 5 year term and 25 year amortization becomes $943.03 principle and interest. You will pay about $29,000 in interest over the 5 years and will be left with a balance of about $168,000 at the end of the 5 year term. That equates to about 17k in savings and a mortgage balance a lot lower after the 5 year term.
Now since you purchased an RRSP you will probably have a refund coming to you. If you put this refund against the RRSP loan you will reduce the amount of interest you pay even further or you could reinvest the refund back into the RRSP to get the tax advantage for the following year and reduce the amount you need to repay back into the RRSP.
There are a couple of things you should be aware of before implementing this strategy though. You need to get the loan from a lender who will allow you to use the funds in the RRSP without having to pay off the loan. (Some lenders require the loan to be paid off before using or cashing in the RRSP funds). Worst case scenario is we would have to place the mortgage with the lender you have the RRSP loan with. You also need to ensure you are speaking to a professional to ensure you are pre qualified for the correct amount as we need to include the new loan payment in the equation. Also the RRSP needs to age for a minimum of 90 days before you can use the funds.
There are a lot of different strategies in the market place so ensure you are talking to someone who knows what is happening in the market and has the ability to think outside the box. As the TMG slogan goes – Think Outside of the Branch. It could save you a lot of money in the long run.
As always comments and suggestions are encouraged and appreciated.
Eric Gall is the owner of Avanti Mortgages (operating as a mortgage specialist for TMG Atlantic). If you are purchasing, refinancing or renewing your mortgage contact Eric or check out his website and apply online.