How to Save for Your Home Down Payment

In the preceding post, we discussed ballparking how much home you want or need and how much down payment you’ll need. From there, you’ll need to make a savings goal and plan to reach it. This post will cover where to start and how to do that using the options available to you.

I will also share my algorithm for those who must prioritize which tax shelters to use to maximize the accessible cash for their down payment.

Baseline Situational Awareness

To plan for a home down payment, you must understand your current situation and define your goal. Let’s start with your current situation, as it may help ground you when setting your goal.

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Your Current Debt Level

Your ability to obtain a mortgage depends partially on your current level of debt. So, paying down your existing debt is usually a priority. That is critical for high-interest debt, like credit cards. In contrast, interest-free debt, like a Federal student loan, is not a priority. A large line of credit is also a liability.

Some people plan to use their line of credit to make a down payment on a home. The bank is wise to that. They may not consider money that you took out of your line of credit in the months leading up to the mortgage as part of the down payment. Some people get around that by moving the money earlier. However, you should ask yourself whether this is a sign that you are over-reaching, either by targeting a home that is too expensive or by buying before you are ready. I know people who maxed their line of credit to buy their “dream house”, but spent the next few years living on lawn furniture and having several empty “yoga-rooms”.

The lender may even treat your unused line of credit as debt. You have access to it. If you max it out right after buying your home, it could increase the risk of defaulting on the mortgage. That said, with CMHC-insured mortgages, banks are pretty blazee about risk since it is CMHC taking it and you paying the premium. Still, if you are incorporated, it may be worth considering paying off and closing your personal line of credit. You could open a corporate line of credit. The interest on a corporate line of credit is also more easily deductible if you use the money to support your business. For example, making payroll (even to you) or paying for other overhead.

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Your Current Liquid Financial Assets

Even though you are just getting serious about planning for a down payment now, you may already have been investing for a while. Take stock of your existing financial assets. We’ll get more into this later, RRSPs (with the exception of a group RRSP at work), TFSAs, and personal or corporate accounts may all play a role in funding a home purchase. The FHSA was made for this.

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Gifts From The Bank of Mom & Dad

The high barrier to entry into home ownership has alarmed many parents and grandparents. Many older Canadians also view their home as the best investment (even though that is debatable). So, it is no surprise that many are looking to give money to their offspring to help them buy a first home.

As the potential recipient, do not let this push you into buying more than you can afford or too early. That is an important decision with high ongoing costs and a high exit cost if you make a mistake.

As a potential donor, parents and grandparents should also be aware of the best options. On the one hand, giving money to a young homebuyer to invest in an FHSA or another tax-advantaged account is like having the government “match” your home down payment donation by saving the recipient money on taxes. However, you should also be aware of the potential for your gift to become part of a divorce settlement if you go that route. A matrimonial home’s value may be divided evenly, even if one spouse contributed more to its purchase.

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Loans From The Bank of Mom & Dad

There are a few ways to address the risk that a divorcing partner will get some of the money. One is for the parent to establish a trust that makes payments to help offset the costs of ownership. That comes with its own extra costs and complexity. Another option is to make the “gift” a “loan” instead, with a condition of the loan being repayment prior to the sale of the home. You can choose to forgive the loan later, or if the sale is due to divorce, demand repayment.

There must be appropriate formal documentation for that strategy to work, and it may still be challenged in court if no interest is paid. Registering it as a second mortgage may help. An institutional mortgage lender may also require that funds from family be formally documented as a “gift” when evaluating mortgage eligibility. A loan will be treated as a liability on the balance sheet. Another option may be to have a marriage contract that addresses the issue. Either way, you should seek legal expertise.

Target, Automate, Adjust

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Ballpark Your Price & Target

The preceding post dug into how to consider what you want and/or need in a home, and how much down payment to target. You may need to adjust your expectations when weighing the ongoing costs of ownership against your other life priorities. The best way to figure out how much you can afford is to model that with a budget. Those are the first two steps in making a down payment savings goal. Price is one variable, and the other big one is your timeline. Take a guess at that. It is a guess because what actually happens depends on your finances, your willingness to compromise, and the pressures that your life, emotions, and social circles buffet you with. Still, a plan with clear goals and an understanding of the trade-offs helps you to be resilient and make more deliberate decisions.

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Automation Beats Willpower

Once you have your annual savings target, plan monthly contributions. Automating the plan to move the money from your daily-use bank account before you can spend it is more likely to be successful than trying to save what is left each month. If you find that this is putting you in a precarious financial position, that is a cue that you need to adjust your plan. Consider whether you want to be more flexible with your home purchase timeline or price, or make a sacrifice in another area of your life. It is far better to do this while saving than after locking yourself into the commitment of a home purchase.

If you have maxed out your tax-sheltered accounts, then you can move money around to plunk a lump sum for new contribution room at the beginning of each calendar year. Okay, this is when you ask, automate my savings to which accounts? Which tax shelters? Let’s go there next.

Prioritizing Accounts To Boost Your Down Payment

There are tax-advantaged accounts that you can use to access money for your home down payment when it’s go-time. I detailed them in previous posts. The FHSA is a gift, if you qualify – a tax deduction now, tax-free growth, and tax elimination when used for a home purchase. Open one early to start accruing room, and try not to leave more than $8K unused. You can make up for $8K in unused room on short notice. The FHSA has a lifetime $40K contribution maximum, but starting early could grow the money invested inside to much more. A couple could double that.

If it is your first home purchase, you may be able to tap your RRSP using the Home Buyer’s Plan. Naturally, that requires you to have built up a large enough RRSP to take advantage of up to $60K per person. If you have a lower-income spouse, a spousal RRSP and their own RRSP could also be a source for another $60K.

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What accounts should I prioritize to maximize?

The FHSA should be a priority for everyone saving for a home. An RRSP works best for those facing a high tax rate or Canada Child Benefit (CCB) clawbacks due to their household income. For those with a lower income, no CCB, and limited financial resources, the TFSA may be a better option. The RRSP’s deduction from your income is less valuable, and a TFSA offers more flexibility to access money if life throws you a curveball.

For those who can max out all of those accounts each year, you have some options. You can save more using a corporation (if you are incorporated) or a regular personal account. Neither has the tax advantages of registered accounts. A corporation offers partial tax deferral, income-smoothing, and shareholder loans to keep in lower tax brackets.

For those who must prioritize between accounts each year, I made the algorithm below. Importantly, it prioritizes maximizing the money available for a down payment. For those looking to maximize their long-term investments, the algorithm’s last decision changes to make use of all your RRSP room (continuing to build RRSP money rather than putting excess into a tax-exposed personal or corporate account).

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Bank or Brokerage?

The FSHA, RRSP, TFSA, or non-registered accounts are just containers for your investments. If you open these accounts at a bank branch, you may be limited in what you can hold in them to cash, GICs, or their expensive retail mutual funds. That may be fine if you have a short timeline and limited ability to take investment risk, in which case a high-interest savings account is a reasonable option. For those looking for a little more growth, an account at a discount brokerage gives more options. I personally use both Wealthsimple & Qtrade.

Saving vs Investing to Grow a Home Down Payment

As mentioned, accounts are containers. What should you buy in those containers? That depends on your timeline. A short timeline, such as 3-5 years, may require a low-risk approach. Like one of the savings options: HISA, HISA ETF, or money market ETF. You can probably do better than a GIC. If you have flexibility in your price or timeline, or will be adding a lot more money to the post later, you may be able to take on some investment risk. As long as it still does not exceed your behavioral risk tolerance. That is likely to increase your down payment money, but you must also be willing to accept a bad outcome if you are unlucky. Historically, the odds have favored a positive return, but a bad luck downturn could be massive.

I covered what investments to buy in your First Home Savings Account in great detail in a preceding post. It is not specific investing advice (I can’t give that to you), but the same principles apply to all of the money you are saving and growing for a home down payment.

Don’t Just Dream. Act.

I made this post comprehensive because buying a home is a big decision. That decision to buy is separate, but you can start laying a strong foundation, whether you ultimately buy or not. Given the costs of housing, having a solid, efficient plan maximizes your ability to financially achieve your dreams. Still, don’t let the struggle for “optimal” prevent you from getting started. The first few steps are easy regardless of the details. Pay your debt down and start saving. You can come back to this post as you move on to each step. You will inevitably have to adjust anyway. Life is like that. Dreaming and visualization are an important part of the process. It helps you to clarify what you want and don’t want before you buy, and it keeps you motivated while you work towards your goal. Still, you must act to get there.