Homeownership is a major personal and financial goal for most young people. It’s also one of the biggest financial challenges.
With real estate prices seemingly rising endlessly in the most desirable cities in the US and Canada, it can seem impossible to get a foothold in the market. As a result, many young people panic and rush to buy before they can really afford it.
If you can’t afford to put 10% down, you can’t afford a home
Sad news everybody: if you’re scraping together 5% to put down on a home (and struggling to even come with that), you’re not ready to become a homeowner.
Homeownership is hella expensive, and this is true long after you get the keys to your new place. Virtually everyone focuses on getting together the down payment because it’s the largest upfront expense, but the ongoing costs of owning property — like repairs & maintenance, mortgage default insurance, and property taxes — can really put a damper on your long-term financial health if you’re not careful. Furthermore, there’s always the risk the value of your home will go down, and when that happens, your mortgage payment will not go down with it!
In order to keep extra cash in your monthly budget and protect yourself from volatility in the real estate market, you need to put at least 10% down on your first home. Ideally, you’d put 20% down, but with the average house price in Canada nearly $500,000, there are very few 20- and 30-somethings with a spare six-figures lying around. A 10% down payment is enough to lower your monthly mortgage payment, reduce your mortgage default insurance, and secure enough equity in your home to whether small dips in the real estate market.
A 5% down payment gives you only 1.6% equity in your home because the rest of the cash goes to mortgage default insurance. If you put 10% down, you’ll secure 7.2% of equity in your home. In other words, saving another 5% of the house value will give you almost 6% more equity. Talk about a great return on your investment!
Save in your RRSP first, TFSA second
I’ve made the argument for saving your down-payment in your Registered Retirement Savings Plan (RRSP) instead of your Tax-Free Savings Account (TFSA) before, but fundamentally it boils down to one simple truth:
It is better to spend tax-deferred savings than tax-free savings.
The TFSA is the best retirement savings vehicle available to Canadians, but most don’t see it that way. Because the account has no rules against or penalties for withdrawals, most people use the TFSA for everything but saving for retirement. This is where they stash their vacation savings, their spending money, and, yes, their house down payments. But constantly making contributions and withdrawals from the TFSA undermines its tax-free power. You don’t need to earn tax-free interest on your vacation savings, you do need to earn it on your retirement savings.
In Canada, you can withdraw up to $35,000 from your RRSP for a down payment on your first home under the First Time Home Buyer Plan. Of course, in order to make a $35,000 withdrawal, you’ll need to actually have $35,000 in your RRSP in the first place, so start saving. Once you’ve banked $35,000 there, you can start saving the rest of your down payment in a TFSA or unregistered account.
Cash is king
When it comes to saving up your down payment, I want you to be bored. I want the excitement of watching that account grow to rival watching paint dry. It really should be that dull. Why? Because if you’re investing your down payment money and it starts to get exciting, you’re taking on too much risk.
Your down payment isn’t about risk or growth, it’s about savings.
The stock market has been on an uncharacteristically long 8-year bull run, which has been really fun for all of us but is starting to feel like a super fun carnival ride we’re not sure will ever end and therefore is making us nauseous despite its awesomeness. Heads up: it will eventually end. And when it does, that’s the last place you want your down payment money to be.
It’s hard to put tens of thousands of dollars in a savings account returning 1% (or less), but if you want this money to put a roof over your head later, you can’t afford to take on the risk required to earn a higher return. If you’re going to be buying a home in 2 years or less, your down payment should be in a simple savings account. If your plan is to buy within 2 to 5 years, you can work GICs and super safe mutual funds into the mix. But unless you’re not planning to become a home owner for 5 years or more, stay out of the stock market.
Don’t forget to set aside extra for those added costs
Land transfer taxes, realtor fees, home inspection costs, and sales tax on your mortgage insurance can add anywhere from $5,000 to $15,000 (or more!) to the cost of buying your first home. Again, this is why a 5% down payment is NOT enough! There are so many additional costs to purchasing a home, that if you only saved enough for the 5% down payment, you’re likely going to end up thousands of dollars in debt when you finally purchase.
You’ll need to save above and beyond your down payment fund by at least 15%. This means if you need a $40,000 down payment for the property you want, you’ll need to save an extra $6,000 for possible associated closing costs.
Don’t forget new homes come with a whack of additional expenses, like moving costs and new furniture. If you’re becoming overwhelmed by the price tag of home ownership remember first that I told you so, and second, you can cut costs on moving and furniture far easier than you can cut costs on land transfer taxes. The most important thing is to be aware of what expenses are heading your way and which of them you have to take care of and which ones are avoidable, so nothing catches you by surprise.
Save consistently and wait for the right moment
It’s hard to save up a 10% down payment. It takes a lot of discipline and a lot of time. If you find it painful to sock away hundreds of dollars a month now, just remember you won’t get to ever take breaks from your mortgage. This is good practice!
Once your savings starts to inch closer and closer to your 10% down payment goal, you want to start looking at homes in your price range and watch the real estate market so you can find the right opportunity to buy. This means the right property AND the right moment.
Happy house hunting!