|Contributed by: martingale |
Should you borrow from your RRSP to buy a home? There are several ways to do this. The simplest is to take advantage of the Home Buyers Plan. In this article we'll look at the mechanics of doing this: Is it a good idea to use RRSP money to finance the purchase of a home?
The Home Buyer's Plan
You can borrow up to $20,000 from your RRSP under the "Home Buyer Plan" if you have not owned the home you live in over the last five years. If your spouse has an RRSP, he or she can do the same, so that together you can come up with up to $40,000 under this plan. To withdraw money under this plan simply fill out a form T1036 (TP-925.1-V in Quebec) and submit it to your financial institution. It's important to withdraw using this special form, otherwise it will be considered a regular withdrawl and tax will be deducted.
Once you've got the money you have until September 30 of the following year to purchase a home, and a further one year to move into it and make it your primary residence. The money you withdraw from your RRSP is considered a no-interest loan to yourself. You will have to pay the money back to your RRSP, but you will not pay any interest on it. You must repay 1/14th of the amount every year for 14 years, beginning two years after you withdrew the funds. If you don't buy a home, don't make it your primary residence, or don't pay the money back to your RRSP, then the money you withdrew will be treated as income and you will have to pay income tax on it.
From the point of view of your RRSP this is a bad deal: Your RRSP has lent money at a 0% interest rate, which is a very poor investment. On the other hand, you've avoided paying interest to the bank on your mortgage, and you've received a source deduction on your income for the money when you contributed it to your RRSP. The question we have to ask is whether that compensates you adequately for having a poor investment inside your RRSP.
Generally, the answer is "no", it does not compensate you adequately. Consider that a variable rate mortgage will charge you interest at less than the prime lending rate. Even short-term Canadian government bonds pay a higher interest rate than that. As at the date of this article's publication a variable rate mortgage charges about 4% interest, and a Canadian government bond yields about 4.5%. So, in order to avoid paying 4% interest you have given up the opportunity to earn 4.5% (or more if you're willing to take some risk). That's a dead loss of a half percent on every dollar you withdraw from your RRSP for this purpose.
There is, of course, one situation where this doesn't matter, and that's when you otherwise simply wouldn't have the funds to purchase the home. When you make less than a 25% downpayment on the purchase of a home you get dinged with a higher interest rate, and you have to pay "mortgage insurance". This can up the effective interest rate on your mortgage by a couple of percent, depending on your credit history. Ask your banker to calculate for you what the effective yield on your mortgage will be. If it's significantly higher than the interest rate that you could earn by holding a bond in your RRSP then taking advantage of the Home Buyer Plan may be a good idea.
There are two special situations that you should be aware of: First, you cannot make a contribution to your RRSP and then immediately withdraw that same contribution under the Home Buyer's Plan. You must wait at least 90 days. This does not mean you cannot contribute to your RRSP during those 90 days, just that there must have already been enough money in the RRSP to cover your withdrawl. Second, if you become a non-resident of Canada you will have to repay all of the money still owing to your RRSP within 60 days of leaving the country.
Later in this series we'll look at actually holding a mortgage inside your RRSP, and we'll talk about whether it makes sense to do this from an asset allocation standpoint.
See also: Your RRSP and Your Mortgage: Is it a good idea?