- April 4, 2024
- Posted by: legaleseblogger
- Category: Related News
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### Debate over Down Payment Options for a Primary Residence
I was out for drinks the other day and got into a debate with some friends about how much to put down as a down payment on a primary residence. The friend in question has a house closing at $1.1M and is currently mortgage shopping. He is a 31-year-old married individual with no children and a $200K household income. He lives within his means and has a decent amount saved up.
#### Option 1: 20% Down Payment with Investment in ETFs
One option being considered is to put 20% down as a down payment and invest the remainder of his money in ETFs as a means of potentially maximizing returns.
#### Option 2: Liquidating all Investments for a Larger Down Payment
The other option on the table is to liquidate all investments, including savings accounts, TFSA, and RRSP, in order to maximize the down payment (approximately 75%) and lower the monthly mortgage payments.
The mortgage rates he is considering are as follows:
– 2 Year Fixed Rate: 6.41%
– 3 Year Fixed Rate: 5.75%
The debate centers around whether to put 20% down and invest the rest into diversified, low-fee ETFs for potentially higher returns compared to real estate appreciation, or to make a maximum down payment and save on mortgage interest, especially considering there are no interest write-offs for a primary residence.
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****** just grabbed a
Bro asks a question like this while omitting the one crucial piece of information that would definitively answer it: what the mortgage interest rate is
It depends on your financial goals and risk tolerance. If you go the investment route;
1. Put 75% down on the house
2. Get a readvanceable mortgage
3. Borrow back the 55% to invest (it will be limited to 45% due to new rules – the rest may need to be borrowed from a margin account). Keep that borrowing and investments in a separate account
4. Deduct the interest borrowed for investment purpose from income taxes
Edit: I thought the OP mentioned cash being available. Using RRSPs is excessive and would end up being taxed around 50%. Not worth it, other than maybe borrowing using the HBP. Savings and TFSA are a consideration.
I don’t think anyone has mentioned yet:
The debt/income ratio at the different down payments might determine if they can even get the mortgage they need.
They make $16,000/mnth.
– 1.25mil – 20% = 1,000,000 = 7,500 to 8,000 / month (50% debt/income ratio)
– 1.25mil – 75% = 312,500 = 2,000 to 2,500 / month (15% debt/income ratio).
Mix of option 1/2. Drain the TSFA, and some savings. Don’t touch the RRSP. The RRSP gets taxed as income when you withdraw it. Although they could the use the HBP to withdraw 35K from the RRSP tax free. That would be fine….dont touch the rest. Also my reason for leaving some savings is that there is always shit to buy when you a first time home owner. Your dishwasher will break, need a lawnmower, need blinds, furniture…. I could on and on.
If one can put 75% down in a somewhat hot market, they are already winning the game of life. One option _may_ be better than another but we’re talking about hitting a triple home run vs a quadruple when your team is already up.
I’d go the 75% route. It saves interest. Frees up monthly cash flow. One less bill to worry about in a few years. And since my overall risk profile is lowered by having a smaller mortgage, I can technically invest at a higher risk level.
Also, the interest saved on a mortgage is tax-free (another way to look at it is that interest is paid with after-tax dollars). Not exact numbers, but saving say 5% interest on the mortgage is equal to around 8% of an investment return that one pays taxes on.
Psychologically, housing payments are a huge point of anxiety. There’s something to be said to have a low payment.
Logic suggests if your returns are higher than your interest, you keep it in the investments.
Would depend on how much savings (or liquid assets) relative to the mortgage. If even after the 75% down payment, you have a large comfortable nest egg, then sure. Otherwise, I’d be more likely to do the 20%… keep in mind that money put into the house is locked up unless you want to borrow against it again (which would defeat the purpose of the larger down payment). For most people who aren’t loaded, the 20% would make more sense.
It depends Does the money comes from a tax saving account or not ?
What’s the interest rate of the mortgage ?
Which type of ETF are you going to put your money in?
If you invest the money in the stock market and you lose your job, how hard will it be to find a job to pay the mortgage?
Does a heloc make more sense without leverage?
Once you answer those questions, then the answer is more obvious
If you have enough cash for 75% down, then there’s lots of other options like… 20% down and invest the rest, or 20% down and buy 2nd property with remainder etc.
Cashing out RRSPs with a $200k annual income would see a huge percentage lost in taxes
From what I’ve read on the subject theres a breakpoint where your downpayment gives you the lowest rate.
Typically when mortgage shopping folks that are first time home buyers and paying <20% will get the best possible rate. Reason for this is there mortgage is insured, they default the bank will still get paid by CMHC.
The breakpoint where you will see the same rate as an insured mortgage is 35%.
So if you can manage to get a greater return that exceeds your interest rate, put that extra downpayment % to work.
For the time frame of the mortgage and if they can afford it, I would opt to leave the investments and just make additional payments on the mortgage instead of investing further. Your first 5 years of a mortgage are the most impactful with extra payments. Theres also the complexity of pulling investments to increase the downpayment. TFSAs you will have to wait a calendar year before you can begin contributing what was withdrawn. RRSPs will be treated as income since it is not their first home, thus increasing their taxes.
I’d inquire if their mortgage broker has found the downpayment % where paying additional % down no longer lowers their interest rate.
There are a lot of ifs. How old is your friend? Does he have other savings (LIRA, DB pension, etc.)? How much is the house? Etc. However, either way you look at it, paying off 75% of the house is most likely the wiser option. It’ll open up more cash flow to start saving again.
According to my financial planner, the order of importance is TFSA, RRSP, mortgage, other savings. In the case of your friend, how much he should put down on the house depends on how much of his savings is distributed between the various account types. I would recommend that he leave his TFSA and RRSP alone and liquidate the rest to put towards the down payment.
As others have mentioned, he needs to earn more than 5.75% after tax on his cash account investments to be in a better place than a reduced mortgage. While this is certainly possible, the risk isn’t worth it IMO for a possible few percent additional return.
Not a financial wizard but :
What about putting that 75% down then getting a LoC on the equity of the house and invest? Now the interest on the LoC is tax deductible!!
If someone were to ask if they should have a diversified portfolio of stocks or go all in on one, I think everyone would say to diversify. Wild to me how when that single asset is a house people think it’s a good idea.
I’d do an in between myself lol. There is a huge range between 20-75%.
Save enough to max out TFSA. Put the rest towards mortgage. The real info we need is the mortgage rate and free TFSA room.
A part of this is math, but the answer is risk tolerance and no has a crystal ball.
If he thinks he can get a higher return on the market than the absolute value of the mortgage rate, then keeping his money the market is the better choice. He’s need to include the tax losses of withdrawing from the market to fund the downpayment, if that’s the route he goes, which also helps the argument for keeping his money where it is and doing the minimal downpayment.
The unknown is market performance. I think, at best, were quibbling over a 2% variance on either side. Likely less. I just don’t think it’s worth worrying about. Lots of people would prefer the sure-thing of the mortgage. Having a tiny mortgage payment payment every month, until it disappears to nothing, is going to bring much more cumulate satisfaction than riding the market for 30 years for a slim chance to beat inflation by the smallest of incrememt.
One thing not mentioned is to pay off or consolidate other higher interest debt (eg car payments).
Whatever the friend chooses to do, keep a semi-liquid emergency fund and take advantage of mortgage pre-payment/extra payment privileges.
Those rates are horrible he could get 4.6% with that income and purchase price unless he has trash credit. In which case he should definitely put more down because he’s bad with money.
But to answer your question long term you’d expect a higher rate of return from investing the funds. But that’s not guaranteed.
I’d put 60% down keep 15% for safe measure. Calculate the saved income to interest ratio. Each month put that amount of interest that would of went to the bank back into a saving account instead of paying the interest and trying to use the markets to combat it. Don’t play the game be the game.
Any rrsps cashed will be taxed at 40 percent. Thus cashing any rrsps here will be a big losing decision
You want to cash them when you are having a down year like laid off or after you stop working
I would do whatever maximizes cash flow & ideally sees that cash flow increase every year.
Liquidating rrsp shouldn’t be on the table. That contribution room is permanently lost. Do use home buyers plan if you wish, but that is a wash and if income goes up it’s actually a negative.
Liquidating tfsa is a wash. Your equity on your home is tax free so it acts like a guaranteed rate of gain equal to your mortgage, guaranteed. That’s a choice about cash flows.
I’d also consider a one time FHSA contribution for the tax refund which you can use to replenish your tfsa withdrawal.
The beauty of real estate as an investment is leverage. If you take $100k and buy a rental home and it appreciates 20% you’ve made $100k, or 100% of your investment. And you can rent it out while you wait for it to appreciate which it will eventually over time.
Your primary residence though… That shouldn’t be looked at as an investment. It is a home you live in.
>low fee ETFs as they generally yield a highest return than real estate appreciation
Just to note, he gets the real estate appreciation either way so that shouldn’t factor in. It’s just a question of whether it’s worth it to borrow money at ~6% to invest in ETFs.
I’d lean towards no since most of the ETFs would be taxable. Maybe a good compromise is to keep his TFSA and RRSPs, and put the rest into the down payment.
you put your money where the interest is higher. the downpayment / re paying mortgage fast is like saying you make more money because of the guaranted return of it vs the stock market.
Erm…
Never liquidate rrsp, you get taxed big time and lose the tax shield for the rest of your life.
Mortgage is one of the cheapest borrowing out there… so not all mortgages are bad.
I would also do a calculation to see what rate you get with and without insurance on the loan. You might want to put 19% down and get insured to obtain a lower rate, might pay for the insurance premium pretty fast.
You have to do a calculation of after tax return of monry earned vs interest cost really.
The answer is: Cash is king, put as much downpayment as you can afford on the mortgage. Also, it pays to be well-off. You can basically do whatever you want since money is just flowing into your bank acct each month. Its great to have lower monthly mortgage payments though because then you can save up cash for emergencies or whatever else comes up.
From an investment perspective, (I know house shouldn’t be an investment) but it comes down to putting significant portion into housing which is putting all the eggs in one basket and you always want to diversify your portfolio. So, I do not recommend the 75% down payment.
I really like this video, it is based in the US but the examples are still pretty relatable https://youtu.be/Wbr32uy6OmE?si=E_BKFxgJNlv8FwQi
Interest rate so high now i did 100% down payment
Depends what his investments are doing. Its not hard to beat 6% in the stock market.
75% is peace of mind but likely comes with a significant opportunity cost in the forgone gains on investments.
Given his household income, payments aren’t an issue and I think he should do 20% down and keep the investments.
There’s also a middle ground between 20% and 75%. i would so do less now, definetely don’t touch rrsp, and can re-evaluate in 2 or 3 years time at renewal
He needs to consider a different mortgage lender, those rates are terrible
do not liquidate rrsp for down payment unless this is for a first time home owner plan.
just on a return basis, put 20% down and invest the rest. negotiate that mortgage rate to get it below 5%. get an investment return above 5%.
Question: is the economic situation getting better in your view in next 5 years or worse?
I see it getting worse, so securing your own place is probably best move in my view.