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RRSP, CMHC, WTF
June 6, 2010 6:00 PM   Subscribe

I need to pay for my new house and anticipated Reno's. Canada's lending laws put a limit on the minimum down payment I need without penalty, and the minimum I can take from my retirement savings without penalty. The two limits don't mesh for me! Help me decide the best way to patch together the money.

I apologize if this sounds too much like a freshman math assignment. Here are the loan details:

280 k$: House Sale Price
1.5 k$: Closing Costs:
20 k$: Anticipated Reno Costs, Next 18 months
301.5 k$: Total Costs

And here is the source of the conflict:

60.3 k$: Minimum required down payment without CMHC Insurance Cost (20% of "sale value")
50 k$: Our Maximum tax-free withdrawal from retirement savings (2 people)

So the question is, where do we come up with the missing 10.3 k$. I can think of several options, but despite an afternoon in front of a spreadsheet, I can't decide which makes the most amount of sense. We could:

A) Borrow 10.3 k$ from a line of credit (probably 1.5% higher interest rate than the mortgage), Add it to our 50 k$ savings for a down payment of 60.3 k$. Get a mortgage of 251.5 k$ with no insurance cost.

B) Borrow 27.5 k$ from a line of credit. Add 6 k$ to our 50 k$ of savings for a down payment of 56 k$. Get a mortgage of 224 k$ with no insurance cost. Pay the closing and reno costs with the remaining funds from the line of credit.

C) No line of credit. Withdraw 50 k$ of savings for down payment. Get a mortgage of 256.5 k$ (5 k% goes to cover the CMHC insurance premium).

D) No line of credit. Withdraw 65 k$ of retirement savings. Pay 5k$ of income tax on the 15 k$ worth that exceeds our maximum tax free withdrawal, leaving us with 60 k$ for down payment. Get a mortgage of 251.5 k$ with no insurance cost.

There are more variables too! We plan to pay a fixed amount a month to cover all loan costs, but we can choose whether to pay the line of credit down more quickly, or the mortgage, or both equally fast. We can also choose to have both loans at a fixed rate, or both at a floating rate, or one on each (the floating rates are about 2% lower now, but are predicted to catch up to the fixed in 2-3 years).

I have a hunch that most of these options amount to about the same thing, but the intervening laws are making the problem hurt my head more than it should. Are there any economist / accountant / finance mefites out there who are bored on a Sunday evening?
posted by Popular Ethics to Work & Money (18 answers total) 2 users marked this as a favorite
 
I am not an expert in Canadian retirement or real estate law, but have you considered the possibility that you cannot afford to buy this house at this time? I know that I would hesitate to finance a down payment for real estate using money I'm counting on for my retirement. I would also hesitate to buy any house if I was using all of my available money for it, leaving no way to pay for higher-than-expected renovation costs or a busted major appliance or a car accident or a job loss or any of the other things that can happen in a life. Maybe things are substantially different for you, but my advice would be to give up on this house at this time and spend a few years saving every available penny until you have enough money to do this in a less risky manner.
posted by decathecting at 6:30 PM on June 6, 2010 [2 favorites]


You don't have any other savings apart from your retirement savings? What happens if you buy the house and then your car breaks down, or one of you has to go to the hospital after falling off a ladder doing renovations?

I would go for
E) Save up some more money outside of your retirement savings and buy a house when you can do it without using most of your retirement savings.
posted by that girl at 6:32 PM on June 6, 2010


To be fair, we've been putting more money into our RRSP than we absolutely need to retire. Most (well all) of our savings have been put into RRSPs in the last four or five years because of the tax break we get for doing so. I look at this as moving my savings from one investment vehicle to another (that will also happen to provide shelter).
posted by Popular Ethics at 6:44 PM on June 6, 2010


Regardless, it sounds like you'd be leaving yourself with no cushion. If you deplete your retirement savings or take out a line of credit to pay for the house, where will the money come from if there is an emergency expenditure or bad turn of events?
posted by that girl at 6:51 PM on June 6, 2010


Thanks for the concern, but not to worry. Our retirement savings contain a fair bit more than the $60k I'm proposing to use here. We have the money to afford the house (and our retirement), the question is how to alot it with the least amount of penalty.
posted by Popular Ethics at 6:57 PM on June 6, 2010


Are you sure you are correct about CMHC insurance? I recall it being based on purchase price, not purchase price plus whatever other stuff you decide to do.

In either case, if you've saved 50k + other stuff that you put into an RRSP, you probably are on track to save enough within 12 months to have a good, non-tied up savings cushion as well as the full down payment amount.

If you are unwilling to wait 12 months, and you don't have family you can borrow money from:

You should not overwithdraw from an RRSP. You should pay the minimum down payment not to have mortgage insurance. I don't think it matters much between a. and b., though maybe if you had a floating line of credit b would be better.

In the future, you should stop locking up all your savings in RRSPs, which have little flexibility.
posted by jeather at 7:01 PM on June 6, 2010 [1 favorite]


And I am not a financial planner etc etc.
posted by jeather at 7:02 PM on June 6, 2010


jeather: Are you sure you are correct about CMHC insurance? I recall it being based on purchase price, not purchase price plus whatever other stuff you decide to do.

It took me a while to track this down. From the Insurance Companies Act section 542.06:
(1) A society shall not make a loan in Canada on the security of residential property in Canada for the purpose of purchasing, renovating or improving the property, if the amount of the loan, together with the amount then outstanding of any mortgage having an equal or prior claim against the property, would exceed 80 per cent of the value of the property at the time of the loan.
(2) Subsection (1) does not apply in respect of
(b) a loan if repayment of the amount of the loan that exceeds the maximum amount set out in subsection (1) is guaranteed or insured by a government agency or private insurer approved by the Superintendent;
So any loans secured by the house cannot total more than 224 k$ (224/280 = 0.8) without paying an insurance premium.
posted by Popular Ethics at 8:19 PM on June 6, 2010


Having just gone through a real estate purchase, I can tell you that the bank wanted to know where the non-mortgage proceeds for the purchase price were coming from. If you anticipate taking it from a line of credit, they may tell you that it's not going to protect you from CMHC insurance... Speak to your banker to know for sure, but in your circumstances, I think you are going to be stuck with insurance.
posted by birdsquared at 8:47 PM on June 6, 2010


Here is the CMHC's info about insurance premiums. Note that the premium is based on the ratio of your loan amount to the value of the house. It is not based on the ratio of the down payment to the total loan, as you assume.

Secondly, in order to qualify for any insurance premium other than the highest rate, you need to use traditional sources of funds for the down payment. Withdrawals from your RRSP are OK for this, but borrowed funds are not (see the footnotes on the CMHC page).

So here are the options you lay out:

A) Borrow 10.3 k$ from a line of credit (probably 1.5% higher interest rate than the mortgage), Add it to our 50 k$ savings for a down payment of 60.3 k$. Get a mortgage of 251.5 k$ with no insurance cost.

B) Borrow 27.5 k$ from a line of credit. Add 6 k$ to our 50 k$ of savings for a down payment of 56 k$. Get a mortgage of 224 k$ with no insurance cost. Pay the closing and reno costs with the remaining funds from the line of credit.

You aren't allowed to do either of these, as the money would be from a non-traditional source of funds.

C) No line of credit. Withdraw 50 k$ of savings for down payment. Get a mortgage of 256.5 k$ (5 k% goes to cover the CMHC insurance premium).

You can do this, but it is sub-optimal.

D) No line of credit. Withdraw 65 k$ of retirement savings. Pay 5k$ of income tax on the 15 k$ worth that exceeds our maximum tax free withdrawal, leaving us with 60 k$ for down payment. Get a mortgage of 251.5 k$ with no insurance cost.

$5000 is a big tax hit, so this isn't great either.

More reasonable options (I'm assuming here that you qualify for CMHC's standard premiums:

1) Withdraw $50K from your RRSPs, put $42K down and get a mortgage for $238K. Pay the premium of $4165 (ratio 0.85) and use the remainder of the $50K for closing costs and to start on your renovations. Use your line of credit to pay for renovations as needed and for emergencies.

2) Withdraw $56K from your RRSPs, put it all down and get a mortgage for $224K. Presumably, pay no insurance premium as your ratio will be 0.80, but pay around $2K in taxes. Use your line of credit for closing costs, emergencies, and renovations.

Of the two options, number two makes more sense (with option one, your net worth goes down $4165 plus closing costs, while option two only reduces your net worth by about $2K plus closing costs). You'll pay a little more interest over time for option two, as you'll be using your line of credit more, but it won't be that much (~$120 in the first year if the rate is 1.5% higher). Unless you plan to keep that line of credit going for 25 years, option two makes more sense.

Things to think about: Are you sure you will have access to $21.5K+ in a line of credit after you buy a house? Check with your bank. Do you realize that you have to repay your $50K RRSP withdrawal over the next 15 years? You will need to budget for $278 per month, after taxes, to repay this, plus your mortgage payments and payments for your line of credit.

These sorts of things can be a bit tricky and you need to do your homework before diving in. Not to be negative, but the scenarios you present here show that you haven't done that homework. Please check and re-check your assumptions, preferably with someone knowledgeable at your side, to make sure that you aren't overextending yourself financially by taking on too much debt. I hesitate a bit to post this answer, because I am concerned that you need more help with this than AskMe can provide. So please, take this information as a starting point and go through the numbers with someone knowledgeable.
posted by ssg at 8:47 PM on June 6, 2010 [2 favorites]


On non-preview, yes, this is correct:

So any loans secured by the house cannot total more than 224 k$ (224/280 = 0.8) without paying an insurance premium.

But this is not the same as what you have written in your question.
posted by ssg at 8:51 PM on June 6, 2010


... and that means options A and D are out. (I was confused because so much literature about the CMHC premium talks about having a "20% down payment". That's not quite the same as "borrowing no more than 80% of the value of the property")

So the choice is either borrow 6 k$ extra on a line of credit (option B) or eat the 5 k$ insurance premium (option C). Assuming my line of credit rate is not so much worse than my mortgage rate that the difference in interest payments is more than the 5 k$ insurance fee, I think the choice should be B.

Sorry to work this out myself publicly. I needed Jeather's push to get me to look up the text of the law. Still, I wouldn't mind if someone could confirm (or dispute) my conclusion.
posted by Popular Ethics at 9:03 PM on June 6, 2010


oh crap, just as I posted, ssg comes along with great info.
You aren't allowed to do either of these, as the money would be from a non-traditional source of funds.:
I'm not sure how CMHC will know where whether the missing down payment is coming from "traditional sources". I could, for instance, sell my car, use the proceeds to meet the down payment (and pay off what's left of the car loan), then buy another car with the line of credit. That's the same thing as using the line of credit for the down payment, but more obfuscated.
2) Withdraw $56K from your RRSPs, put it all down and get a mortgage for $224K. Presumably, pay no insurance premium as your ratio will be 0.80, but pay around $2K in taxes. Use your line of credit for closing costs, emergencies, and renovations.

Of the two options, number two makes more sense .
I agree. I think you've proposed the same thing as my "Option B".

And thanks for the warnings. I'll confirm with the bank that my existing unsecured line of credit (which currently sits at 0 balance) will remain available following the purchase of the house. This askMe question is part of my homework. And I assure you, that it won't be the only line of research. Unfortunately there is a lot of misleading info out there (The CMHC and bank "home affordability" calculators suggest we could support a mortgage of $800 k$. Personally I think that's insane.) Thanks again for helping to cut through it all!
posted by Popular Ethics at 9:17 PM on June 6, 2010


I think you've proposed the same thing as my "Option B".

Not quite. I'm proposing you take $56K from your RRSP, while your option B has $50K from the RRSP and $6K from the line of credit. I wouldn't risk trying to get around the requirement that the money not be borrowed if it comes from your line of credit. When you take the money out of your line of credit, it will show up on your credit report. If anyone looks at your credit report after you've taken out that money, then it will be pretty obvious what you have done. Be careful.
posted by ssg at 9:34 PM on June 6, 2010 [1 favorite]


When I bought my house (in Ontario, Canada) I had to show a few bank statements that proved that I had the money for the downpayment (and that it didn't just "show up" in my account with no explanation).

Where are you planning on buying? Did you know that many in Canada are foreseeing a housing decline similar to the US over the next few years?
posted by davey_darling at 5:30 AM on June 7, 2010


I'm fairly sure you can't borrow from a line of credit to pay the down payment on your house. You need actual money. They would presumably lend you less if you were going to be servicing two loans, the line of credit and the mortgage. You are right that you might be able to get around these rules, but it's probably not a good idea.

Also, this has nothing to do with your question, but a lot of people expect the housing market to cool down over the next half a year or so. (I know people who have sold units recently, and they had a tough time getting offers period for nice places downtown. A few weeks back this wouldn't have been the case.) So option (E) might be to wait things out a little bit longer, if you think the house you are looking at might be priced higher than it should be.

I think you should take $56K from your RRSPs, pay the income tax hit, and then use that amount for your down payment. You could do reno work as needed over the coming years. You could use your line of credit if needed.
posted by chunking express at 7:09 AM on June 7, 2010


Where are you planning on buying? Did you know that many in Canada are foreseeing a housing decline similar to the US over the next few years?

Yes, I know. I'm trying to avoid completely losing my shit about that. Thankfully I'm in Hamilton, a city which has stubbornly refused to follow the national trends in price spikes and falls (we're no Vancouver). The timing is just this way for me - I need a new apartment, the house came at a bargain, and I can get the loan I want now. If housing prices tank next year without rebounding, I'll let you say "I told you so".

I've decided that we can put together the $56k down payment + closing costs without using a line of credit, so there's no "getting around the rules" issue. Now I just have to decide how to finance the renos. The CMHC fee is looking attractive only because it makes this whole mess a little simpler (only one loan at a low rate).
posted by Popular Ethics at 2:11 PM on June 7, 2010


The deal is done. For anyone that might be following my path, there are a few hidden pitfalls I discovered. Unsecured lines of credit usually have really aggressive minimum payments (3% / month, or paid off in three years). That prevented us from financing the renos as planned. In the end we managed to secure a deal through the bank of Dad. In the long run we can apparantly have an appraiser up the value of our house to reflect the renos and then refinance the mortgage at the higher value (and pay off the BOD loan). That may have some tax implications though.

I guess that's why 65% of first time home buyers opt to pay less than 20% down!
posted by Popular Ethics at 8:15 PM on July 7, 2010


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