Notwithstanding the ongoing pandemic, the real estate market in most of Canada continues to thrive and home prices continue to rise. Some of that may be attributable to the fact that, while prices are rising, the cost of financing a home purchase is near historic lows.
Typically, first-time buyers trying to get into the real estate market face two hurdles. The first is the need to put together a sufficient down payment, and the second is their financial ability to meet ongoing mortgage repayment obligations (i.e., the monthly mortgage payment). Increases in the cost of homes in Canada mean that, even at near record low mortgage lending rates, the size of the mortgage (and, therefore, mortgage payment amounts) can be prohibitive.
Adding to that difficulty is the fact that the rules governing mortgage lending practices and mortgage repayment requirements have become increasingly stringent over the past decade. While it was for a brief time possible to purchase a home in Canada without making a down payment, and to stretch the mortgage amortization period (the length of time over which the mortgage is repaid) to 40 years, that is no longer the case. Today, prospective homeowners must provide a down payment of at least 5% of the purchase price of a home, where that purchase price is $500,000 or less. Where the purchase price exceeds $500,000, the required down payment is $25,000, plus 10% of the portion of the purchase price which is over $500,000. And, where the purchase price is $1,000,000 or more (as it could well be in Toronto or Vancouver) the required down payment is 20% of the purchase price, or at least $200,000. In addition, where the down payment amount is less than 20% of the purchase price (which is almost always the case for first-time home buyers) the maximum amortization period for a mortgage is 25 years.
Some prospective home buyers have other sources from which a down payment can be put together — often a loan from family members or even, for a fortunate few, the gift of a down payment from parents or grandparents. For those not in such a position, however, there are a couple of alternatives. The first provides assistance with putting together a down payment, while the second reduces the amount of monthly mortgage payment for first-time buyers.
Home Buyer’s Plan
The Home Buyer’s Plan, or HBP, allows first-time home buyers to borrow funds, tax and interest free, from their registered retirement savings plan (RRSP) to serve as, or to augment, their down payment.
Under the HBP, a first-time home buyer who has entered into an agreement to purchase or build a home can withdraw up to $35,000 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 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 $35,000 from his or her RRSP and both withdrawals can be pooled to come up with a down payment.
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 October 31, 2020, will be considered a first-time home buyer if he or she had not owned and occupied a home after the end of 2015, the four full calendar years being the period between January 1, 2016 and September 30, 2020. Where the prospective homeowner is married (including a common-law partnership), the same requirement applies to the 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 2020, the first repayment must be made in 2022. Each repayment is generally 1/15th of the amount withdrawn so, a maximum withdrawal of $35,000 would mean an annual repayment amount of $2,333. (Such repayments are, of course, in addition to regular required mortgage payments.)
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 is 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 an RRSP to put together a down payment on a first home has both upsides and 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 governing HBP are detailed and can be complex, and it is important to be aware of the ins and outs of those rules before deciding to commit to the program. More information on the HBP can be found on the Canada Revenue Agency website at https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/rrsps-related-plans/what-home-buyers-plan.html.
First-Time Home Buyer Incentive
The second option open to first-time home buyers reduces the amount of monthly mortgage payments which they are required to make, through a kind of shared financing program with the federal government. This program, the First-Time Home Buyer’s Incentive (FTHBI), which was introduced by the federal government in the 2019 Budget and became available about a year ago, has two advantages. First, it does not require the prospective home buyer to temporarily deplete RRSP funds (or to even have sufficient funds in an RRSP) and, in addition, does not require any repayment by the homebuyer until the home is sold (or 25 years later, whichever comes first).
Under the FTHBI, a portion of the mortgage principal amount on the purchase of a first home can be financed through a shared equity mortgage with the Canada Mortgage and Housing Corporation (CMHC). Essentially, CMHC will provide partial financing for the home purchase but will not require payments to be made on the financing portion which it provides for the first 25 years of home ownership, or until the house is sold.
That CMHC portion will be 5% for purchases of existing properties and 10% on purchases of newly built homes. An example provided by CMHC illustrates the calculation, as follows.
A borrower purchases a new $400,000 home with a 5% down payment of $20,000, which would mean a mortgage of $380,000. With 10% of financing ($40,000) provided by CMHC, the borrower’s total mortgage size would be reduced from $380,000 to $340,000, reducing monthly mortgage costs by as much as $228.
There are, of course, limitations and criteria which apply to those seeking to take advantage of the new program. First, it is available only to those who are first-time home buyers (as defined for purposes of the HBP) and who have total household income of less than $120,000 per year. As well, in order to qualify for the shared equity program, the mortgage amount (including the shared equity portion) cannot be more than four times the purchaser’s annual household income. Since the upper income limit to qualify for the program is $120,000, a qualifying mortgage therefore cannot total more than $480,000.
It is important to note, as well, the rules that apply with respect to repayment of the CMHC portion of the mortgage financing amount. That repayment amount is not the original amount advanced, but rather 5% or 10% (depending on the percentage of the purchase price originally advanced by CMHC) of the home’s value at the time of repayment. In other words, CMHC, having provided financing for the home purchase, shares proportionately in any increase in the value of the home over the borrowing period.
More detailed information on the First-Time Home Buyer Incentive can be found on the federal government website at https://www.placetocallhome.ca/fthbi/first-time-homebuyer-incentive.
Both the HBP and the FTHBI have the potential to provide first-time home buyers with an entry into the housing market which might otherwise have been out of reach. That said, both programs involve significant long-term financial consequences which should be clearly understood by prospective home buyers before making a commitment to participate in either program.
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.