Saving money for a down payment on a home takes time, effort and patience. Having a large down payment can save thousands of dollars over time because the home owner will carry a smaller mortgage. A down payment over 20% will also prevent a mortgage company requiring that you pay mortgage insurance premiums - an added expense that often gets amortized into the cost of the mortgage.
TUTORIAL: How To Buy Your First Home
Some methods of saving for a down payment are faster than others. Here are five tried and true ways to get into a house faster:
1. Home Buyers' Plan (HBP)
If you have money already saved in a Registered Retirement Savings Plan (RRSP), the Canada Revenue Agency allows you to borrow from those funds under certain conditions. You can borrow up to $25,000 from your RRSP if you are a first-time homebuyer, defined as someone who has not owned a home in four years. If you are purchasing the home with a spouse, he or she can also withdraw up to $25,000 from their own RRSPs.
In the second year after the withdrawal, you begin paying the funds back into your RRSP for a period of 15 years. If, in any year, you do not make the required repayment, the amount is included in your taxable income. Some financial planners recommend borrowing money to make RRSP contributions, then withdrawing them under the HBP. There are risks and rules surrounding this strategy and it should be discussed with a tax accountant before attempting. (Increasing your savings will provide tax benefits - and peace of mind. Check out Maxing Out Your RRSP.)
2. Mutual Funds
If you do not plan to purchase a house for three or more years, you may consider putting money away every month in an automatic investment plan. These funds can be invested in mutual funds, which mimic various sub-sets of the equity and bond markets. For example, if you invest in a mutual fund consisting of a portfolio of mining companies, the returns will follow the overall mining sector. For shorter time horizons, mutual funds are not a good choice as they can be volatile in down markets. To lessen the risk of market movements, you can invest in a real estate fund. If real estate markets drop, your fund will be worth less, but so will the value of your new house and the amount you will need for a down payment.
3. GICs and Other Fixed-Term Investments
A safer - but more slowly-growing - way to save for your future home purchase is through guaranteed investments such as GICs and bonds. These investments have fixed rates of return so that you know what to expect and when they will mature. There are two potential downsides of fixed term investments. The first is that the interest rates are typically low. The second is that, if you find your dream house while the investments are still locked in, you will likely pay penalties on early withdrawal.
4. Canada Savings Bonds (CSBs)
CSBs are a type of fixed-term investment offered by the federal government. They also offer a relatively low interest rate but have the advantage of being backed by the financial strength of the government. CSBs can be purchased for a minimum amount of $100 and are, therefore, useful in an automatic savings plans. When CSBs mature, you can instruct the bank or investment broker to automatically re-invest them. As the time for buying a house comes closer, you can begin to invest in shorter-term CSBs. (They may not be sexy, but bonds offer undeniable benefits to investors. See Savings Bonds For Income And Safety.)
5. High-Interest Savings Accounts
If your time frame for purchasing a house is short, it's important to not leave your money locked in or leave it to the whims of the market. There are many options for high-interest savings accounts. Many of them are online institutions that you link to from your checking account at your home bank. It is simple to set up an automatic savings plan to have set amounts of money transfer over every month or every pay day. The funds are easy to obtain when you are ready to buy as they take only a few days to transfer back to your checking account. Another benefit is that few-day window along with no debit card attached to the account will prevent most impulse buying prior to the home purchase.
TUTORIAL: Mortgage Basics
The Bottom Line
The most important consideration for a savings vehicle to buy a home is the length of time you have to save. In short time frames, the funds need to be available and have little or no risk of eroding. When the time frame is longer, investments with higher risks and higher rewards are more appropriate.