Get control of your mortgage and other debts

Saving money for a down payment on a home takes time, effort and patience. Having a large down payment can save thousands of dollars over time because the home owner will carry a smaller mortgage. A down payment over 20 per cent will also prevent a mortgage company requiring that you pay mortgage insurance premiums – an added expense that often gets amortized into the cost of the mortgage.

Some methods of saving for a down payment are faster than others. Here are five tried and true ways to get into a house faster:

1. Home Buyers’ Plan (HBP)

If you have money already saved in a Registered Retirement Savings Plan (RRSP), the Canada Revenue Agency allows you to borrow from those funds under certain conditions. You can borrow up to $25,000 from your RRSP if you are a first-time homebuyer, defined as someone who has not owned a home in four years. If you are purchasing the home with a spouse, he or she can also withdraw up to $25,000 from their own RRSPs.

In the second year after the withdrawal, you begin paying the funds back into your RRSP for a period of 15 years. If, in any year, you do not make the required repayment, the amount is included in your taxable income. Some financial planners recommend borrowing money to make RRSP contributions, then withdrawing them under the HBP. There are risks and rules surrounding this strategy and it should be discussed with a tax accountant before attempting. (Increasing your savings will provide tax benefits – and peace of mind. Check out Maxing Out Your RRSP.)

2. Mutual Funds

If you do not plan to purchase a house for three or more years, you may consider putting money away every month in an automatic investment plan. These funds can be invested in mutual funds, which mimic various sub-sets of the equity and bond markets. For example, if you invest in a mutual fund consisting of a portfolio of mining companies, the returns will follow the overall mining sector. For shorter time horizons, mutual funds are not a good choice as they can be volatile in down markets. To lessen the risk of market movements, you can invest in a real estate fund. If the real estate markets drop, your fund will be worth less, but so will the value of your new house and the amount you will need for a down payment.

3. GICs and Other Fixed-Term Investments

A safer – but more slowly growing – way to save for your future home purchase is through guaranteed investments such as GICs and bonds. These investments have fixed rates of return so that you know what to expect and when they will mature. There are two potential downsides of fixed-term investments. The first is that the interest rates are typically low. The second is that if you find your dream house while the investments are still locked in, you will likely pay penalties on early withdrawal.

4. Canada Savings Bonds (CSBs)

CSBs are a type of fixed-term investment offered by the federal government. They also offer a relatively low interest rate but have the advantage of being backed by the financial strength of the government. CSBs can be purchased for a minimum amount of $100 and are, therefore, useful in an automatic savings plans. When CSBs mature, you can instruct the bank or investment broker to automatically re-invest them. As the time for buying a house comes closer, you can begin to invest in shorter-term CSBs. (They may not be sexy, but bonds offer undeniable benefits to investors. See Savings Bonds For Income And Safety.)

5. High-Interest Savings Accounts

If your time frame for purchasing a house is short, it’s important to not leave your money locked in or leave it to the whims of the market. There are many options for high-interest savings accounts. Many of them are online institutions that you link to from your chequing account at your home bank. It is simple to set up an automatic savings plan to have set amounts of money transfer over every month or every pay day. The funds are easy to obtain when you are ready to buy as they take only a few days to transfer back to your chequing account. Another benefit is that by having to wait a few days for fund transfers and having no debit card attached to the account will prevent most impulse buying prior to the home purchase.

The Bottom Line

The most important consideration for a savings vehicle to buy a home is the length of time you have to save. In short time frames, the funds need to be available and have little or no risk of eroding. When the time frame is longer, investments with higher risks and higher rewards are more appropriate.

With mortgage rates low and lenders tripping over each other to entice home buyers, borrowing has rarely looked so appealing.

You can get a traditional mortgage or a line of credit, you can prepay the loan, then turn around and write yourself a cheque, raise your payment or lower it, even skip a payment if you need to.

Interest rates are still the main consideration for most mortgage shoppers, says Nicole Wells, director of consumer lending at ING Direct in Toronto. But the lowest rate may come with lurking restrictions that only reveal themselves later when you try to change terms or switch lenders.

“When you’re looking at a mortgage, make sure you understand what you’re getting into,” Ms. Wells says. Choose financing that suits your particular needs, income and stage of life.

Flexibility is key. Indeed, in a recent survey for TD Canada Trust, respondents said the flexibility to pay off their loan faster and defer or reduce payments in an emergency was top of mind.

But flexibility can involve tradeoffs as well, says Nelly Van Berlo, president and owner of Dominion Lending Centres the Mortgage Source in Ottawa. Lines of credit, for example, are ideal for people who want to pay off their loans as quickly as possible. But costly penalties can make it expensive to switch lenders in the future, she notes.

The following are five ways to put some flexibility in your mortgage loan:

1. Size. If you have the income and a good credit rating, you can borrow as much as 95 per cent of your home’s value, but should you? Probably not. By waiting until you have saved enough for at least a 20-per-cent down payment, you will save on mortgage insurance fees, which can be substantial. The fee for mortgage insurance with a 5-per-cent down payment is 2.75 per cent of the loan’s value, or $2,750 for every $100,000 borrowed – a high price to pay for insurance that protects the lender in case you don’t pay.

Making a good-sized down payment also leaves you room to borrow using a home equity line of credit if an emergency arises or if you decide to renovate. And a big down payment gives you an equity buffer if house prices fall and you have to sell for some reason.

2. Traditional or collateral. Traditional mortgages are secured directly by the property, whereas collateral loans such as lines of credit are promissory notes with the property pledged as collateral. If you want the freedom to switch lenders at some point, traditional mortgages are more easily transferred, Ms. Van Berlo says.

While lines of credit offer borrowers great flexibility, the loan would have to be registered by the new lender if you decide to switch in the future, resulting in large legal fees, she says. As well, lenders charge monthly interest on collateral loans, while interest on traditional mortgages is calculated semi-annually (the more frequently interest is calculated, the more interest you pay).

If you have trouble saving, the fixed payments of a traditional mortgage may be more suitable because unless you are really disciplined, the temptation to keep drawing on your line of credit may prove too great.

3. Fixed or floating. Choosing fixed or floating interest rates is likely the most difficult decision for new and seasoned borrowers alike because interest rates are unpredictable and are determined by currents in global financial markets. Yet the rate you pay is critical because it will determine how much of a loan you can afford.

The trouble is, interest rates change over time, so you could take out a $200,000 mortgage loan now at 3.5 per cent and find yourself paying twice that amount five years from now. Alternatively, if you lock in for five or seven years now, you will be paying higher rates from the get-go.

The most flexible type of loan is one that gives you the benefit of low variable rates now but leaves you free to scramble for the safety of a fixed term without penalty at the first sign rates are on the rise.

4. Amortization. This is the time over which the loan is spread; the shorter the better, in terms of interest. Over the entire amortization period, the rate of interest you pay will vary. If you are a first-time home buyer, spreading your loan over 30 years may seem like a good idea because it lowers your monthly payments initially. But the longer you owe the money, the more interest you will pay. On a $100,000 mortgage loan at 4 per cent amortized over 30 years, you will pay $71,187 in interest. The same loan amortized over 20 years will cost $45,019 in total interest, a saving of $26,168.

“But I can make extra payments and pay off the loan more quickly,” you protest. The question is, will you?

5. Fees, restrictions and charges. Suppose you have chosen a variable rate mortgage with a lender you feel comfortable with. The lender says you can switch to a fixed-term rate whenever you choose. Before you sign, check to see if there is a difference between the lender’s posted rate and their “special” or discounted rate. The spread can be up to a full percentage point.

“When considering a convertible product, the client truly has to get in writing what they will get for the conversion rate,” Ms. Van Berlo says. “Will it be the posted rate or the special discount rate?”

In the end, “the starting point is your personal budget,” says Farhaneh Haque, regional sales manager at TD Canada Trust in Toronto. “Don’t overextend yourself. Leave yourself breathing room,” she adds, “and really understand the features and options.