A few weekends ago I was at a taxation seminar put on by a local accounting firm and they were pretty much saying that you should use the HBP. They mentioned it several times. They even went on to say that if you currently have some other debt, say a student line of credit, you should be concentrating on paying that off *rather* than contributing to an RRSP. Well I don’t know if I agree with that, especially if your line of credit is at prime, as ours is. Not only that, but contributing to an RRSP gives a tax rebate (which you can then throw onto the debt after having maxed out your RRSPs); paying down debt doesn’t. They were pretty insistent that paying off debt should be the first priority. *But*, they said, you should contribute to your RRSP up to the $20,000 so that you can take advantage of the Home Buyers’ Plan. Huh? They really made it sound like you should contribute *just* $20,000 to your RRSP, then ignore it and continue paying down debt. It didn’t really make any sense to me.

At one point I raised my hand and asked: “Can you compare withdrawing $20,000 from a line of credit to pay for a down payment vs. withdrawing $20,000 from my RRSP? for example, if my line of credit is at 6% or so and my RRSP is earning maybe 8 or 9%?” Their argument was that they thought I would have to have a much larger return in our RRSP compared to our line of credit to make it worthwhile. Their second argument was that you never know what will happen to interest rates in the future. Their answers weren’t that satisfactory and I expected a bit more from accountants. To make a long story short, after I got home, I started reading about the Home Buyer’s Plan.

The Home Buyers’ Plan is often touted as a magical way to get $20,000 needed for a down payment. I say “magical” because it is often explained in a very simple way without discussing the disadvantages, or any discussion of the alternatives. Here are some examples of what I am talking about:

- Assumption Life makes the assumption that The Home Buyers’ Plan (HBP) is a “winning formula.” “This winning formula can thus help you fulfil your dream to own while also making it possible to maximize your RRSP contributions.”
- This TD article “A Larger Down Payment Means Greater Savings“
- This article from North Shore Credit Union talks about the Home Buyer’s and lists the only downside as being “If the $20,000 were left in the RRSP for 15 years, given an annual 3% rate of return, it would grow to approximately $31,200.” 3%!!! I hope that is real return!

As for #1 above, I think the HBP actually makes it harder to maximize your RRSPs. You will now owe money back to your RRSP and you may be saddled with a fat mortgage on a house that is slightly more expensive than what you might have normally bought had you not taken money out of your RRSPs. You might have a tough time paying off that big mortgage, paying of your RRSPs, and maxing them out every year going forward.

Contrary to what TD says in #2 above, although a down payment means greater savings, I don’t think the HBP necessarily means “great savings.” Here is a comparison between HBP and non-HBP using actual numbers (10% compound return in RRSP, 8% interest on mortgage). It works out roughly the same.

#3 is just laughable. I don’t know where they get their 3% rate of return from. They also claim that “if the homebuyer doesn’t use the RRSP, he/she will acquire a larger mortgage and may possibly even need to purchase mortgage insurance for a high-ratio home loan, which is 3.75% of the mortgage amount.” First of all, 3.75% is wrong, the max is 3.25% or 2.90% (I can’t figure out which, I think it was just lowered though). Perhaps their numbers are out of date. Second of all, if you’re buying a house on the North Shore (North Vancouver), $20,000 isn’t going to lead to a 3.75% premium (from 0%), although it may move you from a lower premium bracket (3.25%) to a higher one (3.75%).

Here’s what I see as the basic alternative to the HBP: Leave the $20,000 in your RRSP and add an extra $20,000 on to your house’s mortgage. This might leave you short of the 25% mark required for you to be exempt from the CMHC premium (of up to 2.75%). Or, it might move you from one CMHC premium bracket to another. This leaves you with a few alternatives, hold off on buying a home until you’ve saved up another $20,000 or take out a loan for $20,000, thus avoiding the CMHC premium (actually I am not sure if the CMHC looks at your other debt or not, if they do consider your other debts, what I just said may not work). You can get everything in between here. In the case where you have 0% down payment you could, again, take out a $20,000 loan or just increase your mortgage by $20,000.

I’d also like to remind you how little $20,000 is nowadays, especially if you are living in Vancouver and buying a condo for $400,000. A 25% down payment would be $100,000. If I get $20,000 of that from my RRSP or from a loan, it not too significant. If you are a couple, the Home Buyer’s plan allows you to take $20,000 from each RRSP which makes it a bit more significant.

The big downside of the Home Buyer’s Plan is that the rates of return from the equities and fixed-income investments in your RRSP may be much better than the interest rate on your mortgage. The amount of lost gains in your RRSP from taking out the $20,000 may be more than the amount of interest you save by reducing the size of your mortgage. The main upside of the home buyer’s plan is that it might allow you to reduce the amount of your CMHC premium. However, another way to reduce the amount of your CMHC premium would be to take out a loan and apply it to your mortgage. In this case, the same logic I used in the beginning of this paragraph also applies. Your RRSP’s rate of return might be higher than the interest rate on your loan. Another downside of HBP is that it can be a disadvantage to have your RRSP descend from $20,000 to $0, let’s say. First of all, when you have $25,000 or more in an RRSP, at some institutions this means you are except from the $125 annual RRSP management fee. Secondly, at E*Trade, for example, when you hit $50,000 in assets your commissions are reduced from $19.99 to $9.99/trade. Lastly, if a bear market is just winding down, that is the worst time to be selling $20,000 in equities from your RRSP.

There is a book from the CMHC called “Impact of the Home Buyers’ Plan on Housing Demand.” It says that “even when the individual has to borrow to make the repayments to the RRSP, there is still a net financial gain.” I think what they are trying to say is that taking money out of the RRSP under the HBP and then paying it back into the RRSP by taking out a loan. I would like to see their actual numbers but I can’t get the report to download.

When you pull $20,000 from your RRSP for HBP, you’re saving about 5.25% mortgage interests. A dollar saved is a dollar earned. So your $20,000 is really earning 5.25%. Secondly, the dollar saved is an after-tax dollar. If your marginal tax bracket is 40%, the $20k is really returning 8.75%.

Not all returns are created equal, since you must consider the risks. 8.75% guaranteed return is super. To earn that inside RRSP, you’d need to increase your risks.

You’re not limited to just $20k per home. Your spouse can also contribute another $20k. The CMHC insurance saving is real. You can add that to the 8.75% guranteed return.

I’m about to make a general statement. 2007 is a bad example as RE appears way over valued. In general, RE goes up about 6% tax-free per year. While you’re waiting to save the 25% downpayment, you’re wasting the 6% capital gain per year. Again, this is a general statement.

It’s not easy to borrow your downpayment and still qualify for the mortgage. The second loan adds to your overall liabilities. They won’t give you a mortgage if your debt equity ratio is too high.

Thanks for your comments.

When you pull $20,000 from your RRSP for HBP, you’re losing x% in lost gains. So you if x% > 5.25%, subtract off the 5.25% to get the net loss.

But if your before-tax gain inside an RRSP is 10% annualized, can you just say that the after tax is 10% * (1-40%)?

Also, while you’re saving up for a 25% downpayment you will be making some rate of return on that (not as much as a capital gain on the entire home, but I don’t think it’s negligible). And as you said, 2007 is a bad example…but I can’t see 6% in housing for the next few years.

Lots of good points. Especially about risk (or lack of) associated with a return.

I thought so about the second loan… You can’t exactly hide it or anything. Although, I think I remember that they do something like this: they allow ~32% of your gross monthly income to go towards the mortgage, and an extra 10% for other debt, so they’ll approve you for a mortgage, where up to something like 42% of your monthly income is total debt-carrying expense, and where up to 32% of your monthly income is for the mortgage. But if you have no loans, will the bank actually approve you up to 42%?

BTW, did you see the article I linked to above? The only part I can’t figure out is why they subtracted $19,999.80 in the second case.

No problem Dave. It’s an interest topic.

>>”But if your before-tax gain inside an RRSP is 10% annualized, can you just say that the after tax is 10% * (1-40%)?”

That’s correct. It’d be 10% * 0.6, which is 6% after-tax gain. To make an apple-to-apple comparison, we need to decide at the beginning if we’re going to use pre-tax calculations or after-tax calculations, and don’t mix and match in the middle. I’ll use pre-tax if that’s alright with you.

I’m not an expert in their loan approval process. For the purpose, lets assume that they allow you to finance the downpayment somewhere else. Without collateral, the extra loan won’t be cheap. If you get an unsecured LOC, the rate is normally > prime + 1%. Prime is 6% so the interest rate is 7%. If you use your HBP money, you’re saving 7% AFTER-TAX which is 11.67% pre-tax assuming 40% marginal tax rate.

11.67% is the guaranteed return with HBP. The 10% return you mentioned for RRSP is the expected return with risks.

I agree that RE is too expensive so entering the market may not be smart. Don’t forget that HBP is a tax-strategy, not an investment strategy. The validity of HBP doesn’t depend on the valuation of the market. Whether you decide to buy a home now is a decision that you should make PRIOR to HBP even comes into the picture.

I read the link you provided, but the numbers didn’t make sense to me. I don’t think it needs to be that complicated.

Whoops. Please ignore my comment about not being an investment strategy. By following HBP, you’ll have to give up your RRSP investments. Sorry about that.

A 10% pre-tax return inside an RRSP cannot be converted to a post-tax return by just multiplying it by 0.6, so I think you’re comparing apples and oranges a bit.

Here’s an example:

$10 in an RRSP. Invested for 100 years at 10% compounded annually. After 100 years it will be $137,806. If you withdraw that all at once, you will pay let’s say 40% marginal tax. So post-tax your RRSP is worth $82,684. Now let’s calculate the return, going from $10 to $82,684 in 100 years. I get 9.4% in my calculation.

I have never actually sat down and looked at this before, so I could be wrong.

I think I know where the ATR=PTR*(1-T) comes from, where ATR is the after-tax rate of return, PTR is the before-tax return and T is the tax rate. That probably comes from a non-RRSP account where you are selling and buying new stuff every year, or earning taxable interest income on it and paying tax rate T on the gains. For example a savings account with $1000 in it that pays 10% interest every December is going to have an after-tax annual compound rate of return of 10%*(1-T) where T might be 40%.

You guys are confusing me (not hard to do). I just did a similar calc as Dave but I used $1000 @ 10% for 25 years (more realistic?) and if the tax rate is 40% then the rrsp payout would be $6500.82 which works out to an annualized rate of 7.775% – does this number matter?

I also did the similar calc on $600 – which is the net after tax amount of the $1000 I used in the first example. This would represent money invested outside the rrsp. $600 @ 10% for 25 years works out to…$6500.82!

In this particular case the 10% return inside the rrsp corresponds to the 7.775% outside the rrsp (ignoring a whole bunch of stuff like dividends/capital gains etc).

Interesting stuff…I’ve always been skeptical of the idea that investing in rrsp vs cash accounts is significantly better but looking at numbers like this is making me think the rrsp is a lot better. If you count capital gains/interest/divs on the amount outside the rrsp, it’s hard to imagine it would do better than the amount invested in the rrsp. I’m going to have to spend some more time on this.

Mike, I’m not sure why you used $600 outside the RRSP as a comparison.

Shouldn’t you be using $1000 outside and $1000 inside?

The comparison I was trying to make was taking $1000 of gross income and either putting into an rrsp (hence the $1000 in the rsp) or taking the after tax amount (via the paycheque) and investing that.

Ah, you were taking into account the RRSP deduction/tax deferment …good for you.

I think you’ve analyzed it correctly then. And you’re right, the the return should be identical, you will get out $6500 either way. It’s just:

FV=(0.6*PV)*(1+0.10)^25

or

FV=0.6*(PV)*(1+0.10)^25

The difference as you pointed out is that outside of the RRSP you will have to pay capital gains, interest, and dividends taxes along the way.

I think Harper had some idea 2 years ago or something (during the campaign maybe?) where he wanted to allow Canadians to swap investments outside an RRSP without having to declare a capital gain (ie. to sell 100 shares of Stock X at $1/share and by 200 shares of Stock Y at $0.50/share without paying any capital gain tax on Stock X). You only pay tax when you convert to cash (or something like that). This would make RRSPs essentially useless for non-interest bearing, non-dividend paying investments. I might have blogged about this a long time ago, if not, then I think the Canadian Capitalist blogged about it. Anyways, nothing like this has been proposed in parliament yet as far as I know.

The Home Buyer Plan is only for a maximum 15 years, not 100 years. Since you’re making annual payments back after the first year, the average time the money is outside RRSP is only about 8 years.

$10 inside RRSP will grow to $21.44 @ 10% compound after 8 years. After tax is $12.86.

With HBP the $10 will compound 7% tax-free to $17.18. The original $10 is still taxable at 40%, so after-tax is $6 + $7.18 = $13.18. I’m compounding because in order to compare apple-to-apple, you wouldn’t have new money to pay off the 7% interest each year had you used the unsecured LoC.

In addition, the 10% projection for RRSP is not guaranteed. So if you include risks into the calcuation, the gap is widen.

I still find the article very confusing overall. One question. For person 1, how did the $20,000 RRSP grow to $89,078.41 after 15 years at 10%? Based on my calculator, it should be $83,544.96. It’s over by $5,533.

How come this site keeps erasing my posts?

Silverm, sorry your comment was getting caught in the spam filter for some reason. Thanks for brining it to my attention. I unmarked them all as being spam, so hopefully the filter is better trained now and will not mark posts like that in the future as spam. I then deleted all the identical posts except for the most recent one.

No problem, Dave.

“$10 inside RRSP will grow to $21.44 @ 10% compound after 8 years. After tax is $12.86.

With HBP the $10 will compound 7% tax-free to $17.18. The original $10 is still taxable at 40%, so after-tax is $6 $7.18 = $13.18. I’m compounding because in order to compare apple-to-apple, you wouldn’t have new money to pay off the 7% interest each year had you used the unsecured LoC.”

I think most of your numbers above are right, except in the second situation there should be some of the $10 being paid back in to the RRSP every year.

I’m digging out an old spreadsheet right now I used for this stuff and see if that clarifies anything for myself.

One thing that Mike and I were doing in some of our calculations above was using the marginal tax rate and multiplying that by the value of the RRSP when we should have been using the average tax rate.