I want to buy a House in a few Years... How do I go about Managing my Down Payment?
When it comes to saving for a house, the whole objective should be on saving and maximizing the down payment for your home. Intuitively, the larger amount you put down the less you will have to take out in your mortgage. However, when it comes to maximizing the DP every one seems to be risk Averse (capital intended). While this is perfectly understandable and people do not want to risk anything as they have the money earmarked for one of the most important purchases of their life.
Today I am going to look at a few ways you can maximize and accelerate growth of your down payment while being conservative and taking on moderate risk (if any).
Method 1: Faster growth without the taxes: One of my best suggestions is regardless of your risk level, make sure that your down payment is sheltered in a tax free savings account (tfsa). This way at least the growth on your account is tax free. Your contribution room is still there when you withdraw. For those of you that have never contributed to a TFSA, this means you have a huge chunk of contribution room sitting around.
Method 2: What’s the deal with variable vs fixed and why does it matter?
One of the biggest mortgage decisions will be your fixed vs variable debate? Now what exactly does this mean? When you select a variable rate, the rate is subject to change depending on the rate set by the Bank of Canada (this is also interest rate risk). Now this can be a great idea – because of the savings it can generate when interest rates are lower. Usually, the fixed rates are higher because they offer security and peace of mind. Even if the BOC raises rates by 10% your fixed rate will not change for the term of the mortgage. This is the benefit of the fixed mortgage it offers security by locking in your rate. The variable rate can also be advantageous – It is significantly cheaper as long as the interest rates do not move. It is possible that the rates stay stagnant for awhile like in Canada but no one knows when they will change.
Method 3: More DP equals faster equity buildup
With the down payment obviously the greater you put down the less you take out in a mortgage. With mortgage payments your payment is a mix of the interest charge and principal charge. As you progressively pay down the mortgage these portions gradually change shifting from a heavy interest weighting to a heavier principal weighting. This is because the interest calculated is on the outstanding balance which decreases as you make payments. Therefore, the smaller the mortgage principal the less interest is charged. One of the ways of doing this is accelerating your down payment growth to make your principal smaller.
Method 4: Moderate risk for accelerated growth:
One of the biggest mistakes I find with people is that they never invest their down payment. It always seems to be cooped up in a low yield savings account generating little to no interest. I think this is when something like a blue chip etf or mutual fund is really good. It is generally a conservative investment as blue chips are low growth high yielding companies. Investing or tracking the S&P TSX 60 or the Dividend Aristocrats can also be a good idea. These are indices that are made up of big solid and reliable companies that return more then a savings account while limiting risk.
Method 5: Liquidity is key for the down payment
Liquidity refers to how quickly something can be converted into cash without the process costing you a lot of money. Investments like cash and savings account are the most liquid, stocks are fairly liquid, while tangible assets and term deposits are illiquid. For this reason, I would avoid using term deposits for your down payment. These investments lock in your investments and really limit yourself. With houses, you never really know when the right time and opportunity will be. You want to have access to your money quickly.
Key-Point with Mortgages:
1. Always select an option where you can double up on monthly mortgage payments with no additional costs to yourself. This way if you ever feel you want to pay it down faster that option is available.
2. Research or chat with an advisor to see how you can invest your down-payment in a conservative fashion to generate extra returns.
Disclaimer: All of the above information is my own personal opinion. Please do your research before making any investment decision. Variable and fixed rates will vary depending on the institution. The decision between both is a matter of personal preferences. I do not recommend one over the other. Mortgages rates are also subject to change. To contribute to a tfsa you must be above the age of 18.
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