Where Should I Invest My Down Payment? Simple Explanations

One of the most common questions I get asked these days is where should I invest my down payment? There are a lot of variables involved with this question, but generally speaking, if you plan on being a homeowner in the next 5 years, you should NOT invest in anything that puts your money at risk. Your investment portfolio should be kept for long-term savings goals such as retirement accounts. 

I’m generalizing here, but most people need their down payment money to be safe if they are planning on using it within a 5-year time frame. Which means they can’t afford to take any risks. Sure you could invest your money in the stock market, but are you willing to go for 10% yields knowing that there’s an equal chance of you losing 10% of your money? Most people will likely be uncomfortable with those odds. Fortunately, there are a few options available to you.

Where should I invest my down payment?

For most people, the best option for investing their down payment is to park that money in a High-Interest Savings Account (HISA). The reason that this type of bank account is the best option is that there are zero risks that your money will go down in value. The downside to this is that you won’t be making much of a return in comparison to investing in stocks, bonds, or ETFs. However, HISAs still gave higher interest rates than a normal chequing or savings account. The real draw of this option though is that your money will be safe. There are many HISAs available, but Alterna Bank offers a few solutions which are ideal for people saving for a home.

eHISA – Alterna Bank’s High Interest eSavings Account offers competitive rates in Canada. Since there are no fees with the account and there’s no minimum balance required, this is the perfect place to park your money.

TFSA – Alterna Bank also has a Tax-Free eSavings Account that also pays a good interest rate. The advantage of the TFSA is that you won’t pay any taxes on the interest you earn. Keep in mind that if you have a large down payment, you need to ensure you have enough contribution room in your TFSA if you’re going to use it to hold your money.

It’s worth noting that the government recently announced the Tax-Free First Home Savings Account. This account allows people under the age of 40 to save up to $40,000 tax-free for the purchase of their first home.

Term deposits / Guaranteed Investment Certificates

Another short-term option available to you with a guaranteed return is Guaranteed Investment Certificates (GICs). They typically pay a higher rate of interest compared to a high-interest savings account, but money put into GICs is usually locked in. That might not be an issue for some people, but if you’re not sure when you’ll buy a home, you may want to keep your money in a HISA instead.

For reference, Alterna Bank currently has GIC promo rates that are highly competitive.

Special promotional rates on term deposits can be changed or withdrawn at any time without notice, so if you see a great promotional rate that fits your timeline, it could be worth jumping on.

Some people will also use money market funds, also known as a money market account, since it’s another safe investment option for down payments.

Using the RRSP Home Buyers’ Plan

If you’re a first-time home buyer, another option available to you is withdrawing up to $35,000 from your RRSP as part of the RRSP Home Buyers’ Plan. I normally don’t like the idea of an early withdrawal of your RRSP to buy a home, but there is a strategy here that you can use.

Let’s assume you have $35,000 in cash that’s currently sitting outside of your RRSP that you plan on using to purchase your home. You could simply deposit that into a HISA that’s RRSP eligible and then use the tax refund you get to help increase the size of your down payment. This assumes you have $35,000 handy and the contribution room available to you.

You must meet the following conditions to qualify for the first-time home buyer plan:

• The money you take out of your RRSP must have been in there for at least 90 days
• You must not have owned a home in the last 4 years
• If you’re buying with a spouse or common-law partner who currently owns a home, you can not have lived in that home in the last 4 years
• You must have a written agreement to buy or build a home before you can access the Home Buyers’ Plan
• You must move in within a year and use it as your primary residence
• You must withdraw the funds within 30 days of taking title of the home
• After the first year of taking title, you must repay the amount borrowed within 15 years

Keep in mind that this RRSP early withdrawal loophole can only be used for home purchases. You also need to pay it back within 15 years or else you will face a penalty.

Understanding Risk Tolerance

The reason many people seek out higher returns with their down payment is that the cost of real estate in Canada keeps increasing year over year. What good is making 2% interest if prices jump 4%+ plus every year?

Well, we have no control over prices, but trying to chase those increases with your money saved is a fool’s game. To simply put it, a 5-year timeline is not very long. Markets could go up or down drastically during that time, so you don’t want to be caught in a down market when you need that cash to buy a home.

That being said, you don’t necessarily need to keep your entire down payment in a HISA. Let’s say you’ve set a maximum purchase price and you have a sizeable down payment. Well, you could basically keep 20% of the purchase price safe and then invest the rest.

Why 20%? By having 20% down, you’ll avoid any CMHC fees. Since mortgage rates are so low (currently about 3%), you could invest the rest and hopefully get a higher return in the long run. But a reminder, the money you invest could also go down in value.

Final thoughts

For the majority of people, the only short term investment that makes sense if you plan on buying a home is using a High Interest Savings Account. Putting your risk for a potential return, even if it’s low risk, just isn’t worth it when you are saving to buy your first home. Save the investments for your retirement savings or long-term goals.