November 25, 2008, 6:00 am

Cash Down For a Mortgage: The RRSP Loan Switchback – How to Avoid CHMC Insurance Premium

by: The Financial Blogger    Category: Banks and You,Properties
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A few weeks ago, I wrote 2 posts on how to accumulate sufficient cash down to buy a property. Since the recent credit crunch, banks are getting more difficult in regards to accepting mortgage loan applications. And Since they are afraid, they might not take the time to look at the bigger picture. This post is obviously for people who know how to control their budget and that they are in full control of their personal finance. Please take note that we are not telling you to do what is following, we are simply telling you that it is being done and how to do it.



The RRSP Loan Switchback technique

The technique is simple. If you are young, making a good income but didn’t have time to build up your cash down and you still want your mortgage right away; this is for you. Under the Home Buyer’s Plan (HBP), the Canadian government allow first time home buyers to withdraw money from their RRSP up to 20K per person in order to purchase their property. You have 15 years (plus 2 years of grace period without payments) to put your RRSP money back.

You don’t have enough RRSP investments yet? There is a solution! Let say that your marginal tax rate is 38% and you have 20K in RRSP unused contribution. If you plan on buying a property within the next six months, here is how you can do it: you take an RRSP loan for 20k with a differed payment option in 6 months (interest will still run since the date of the disbursement but your first payment will be in 6 months only).

Around May or June, you should receive a tax return of 7,6K (38% of 20K). Then, you use your tax return as cash down for your mortgage. If you are a couple, you will be able to put 15,2K as cash down for your mortgage. With the 5% cash down rule, you can go up to a property of 300K (if you qualify for such mortgage!).

You may use this money as extra cash down in addition to what you accumulated so far and put 20% cash down on your property. Therefore, you would avoid CMHC insurance premium.

What about the 40K RRSP loan? Are we not increasing our debts?

Not really. In fact, when you purchase your property, you are allowed to withdraw money from your RRSP (once withdrawn, you are not forced to use it as cash down). Then, you pay off your RRSP loans. The only cost of this technique will be the interest charged on the loan between the moment you contracted the loan and you pay it back.

The advantage of this technique:

– You get your property faster

– Since you buy your home now, you avoid the risk of seeing the same house value increasing by 10% by the time you accumulate your cash down.

– You will be forced to reimburse your RRSP contribution which is a good thing for retirement planning.

– May avoid CMHC insurance premium.

The disadvantage of this technique:

– You have to pay interest on a 40k loan for a few months

– Since you are forced to reimburse the 40k in your RRSP over 15 years, which makes additional payment of $2,700 a year ($225 a month) over the next 15 years.

– You better make sure you are qualified for a mortgage and that you want to buy a house. If not, you will be stuck with the payment of 2 20K RRSP loans.

Overall, this is not a bad technique, however, there are definitely pros and cons and it doesn’t suit everybody’s financial situation.

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Comments

I see the benefits of this method but when I purchased my condo I did not dip into my RRSP account at all. Personally I feel that if you do not have enough of a down payment and extra cash on hand then maybe you sholdn’t be purchasing property. There are tons of other hidden costs that many people to take into consideration prior to purchasing real estate.

by: The Financial Blogger | November 26th, 2008 (9:45 pm)

I like the RRSP loan technique because it forces people to invest in their retirement plan in order to reimburse their RRSP withdrawal 😀

[…] I wrote about how to get sufficient cash down to buy your property with an RRSP loan. Today, we are going to look at a more tricky way to literally create cash down for your mortgage. […]

You mention this:

What about the 40K RRSP loan? Are we not increasing our debts?

Not really. In fact, when you purchase your property, you are allowed to withdraw money from your RRSP (once withdrawn, you are not forced to use it as cash down). Then, you pay off your RRSP loans. The only cost of this technique will be the interest charged on the loan between the moment you contracted the loan and you pay it back.

———-
Please don’t make this error people.

You’ve forgotten to mention an additional future cost – that is, reporting the RRSP withdrawal for tax purposes come the next tax year … So that $7,600 (in the 38% tax bracket) that you’ve used for a downpayment will have to be repaid when it becomes taxable the next filing year.

Any other questions, send me an email – I’m a financial planner in the province of Ontario.

by: The Financial Blogger | January 9th, 2010 (10:08 pm)

@Brian,

why would it be taxable the next filling year? you are not withdrawing more money than the HBP, so there is no taxes to be paid on the following year?

Can you please explain your thoughts?

A financial planner from Quebec 😉

TFB

I shoudl clarify.. There are two scenarios being spoken of in this example.. One is to take the RRSP loan and withdraw it ALL under the HBP. The other example was to take an RRSP loan, invest the funds accordingly, and simply use the tax refund as the down payment …

For example: Borrow 20K. You’re in a 40% marginal tax bracket, and you get an 8K refund… You use the 8K as the downpayment, and the 20K from RRSP loan stays invested. THEN, you take the 20 K out and pay off the loan and voila, your downpayment was created out of thin air! That’s in one of the couple examples given above. EXCEPT, if this strategy is employed, you are technically withdrawing the RSP and it becomes taxable. So you use the 8K as a downpayment, but next tax filing year you’ll owe 8K (assuming a 40% MTR)…

I hope that clarifies it… That is exactly what the above “RRSP loan switchback technique” is doing…

disregard two scenarios .. What i mean is, while there is mention of the HBP in the above article, the main concept is to simply use the refund as the downpayment and not tap into the RRSP for HBP. That is the premise behind the “switchback” technique

You don’t pay the tax if you withdraw under the Homebuyers Plan… If using the example above the only loss you would take is to pay the interest on the loan for the next few months, and that the next years (year two after buying the house, then 15 years after) you have to repay 1/15th of the contribution that you made under the HomeBuyers Plan.. so if you withdraw $20K under the HBP, in year 3 you will have to either repay $1333 into your RRSP, or claim an additional $1333 on your taxes for that year.

If you can make the downpayment without an RRSP loan, or without withdrawing from your RRSP, then by jove, go ahead. But for this option, it is good for two reasons – 1 – you get to buy a property before a market jump if you think there will be one and 2 – it forces you to put money into your RRSP in the coming 15 years to repay your HBP contribution.

There’s a couple holes in this strategy. First you have to have the money in the RRSP for at least 90 days before you can withdraw it under the HBP.

“””You cannot deduct the amount by which the total of your contributions to an RRSP, during the 89-day period just before your withdrawal from that RRSP, is more than the fair market value of that RRSP after the withdrawal. “””
http://www.cra-arc.gc.ca/E/pub/tg/rc4135/rc4135-e.html

So you’d have to wait at least 3 months, and be responsible for the interest during that period. I’m hoping this is what @Brian meant by the withdrawal being taxed in the next year. If you don’t wait 3 months it will be (and you’ll permanently lose the RRSP room).

I also have a problem with the line: “you avoid the risk of seeing the same house value increasing by 10% by the time you accumulate your cash down.” If housing prices are increasing 10% in a 6 month period then you should be extremely cautious, as the long term average is around 3%.

Also: “Since you are forced to reimburse the 40k ” isn’t quite correct. Instead of making payments you /could/ count the $2,700 as income each of the 15 years, and pay taxes on it. This might make sense in a year when someone isn’t working. Otherwise it’s likely better to contribute at least $2,700 to RRSPs over the year.

Oh, and it should also be mentioned that using the strategy you’re simply pulling the future rebates you would have received back to the current year. If you’re in a lower tax bracket now then you will be in 5 years you may end up costing yourself money, as the $2,7000 you contribute in 5 years will not generate any tax refund. Then again if you’re using it to avoid CHMC fees it might be a wash.