Unusual mortgage strategy

Q – My wife and I are interested in buying a house with a 25 percent down payment. If we manage to do so then we won’t have to pay mortgage insurance, otherwise the insurance will cost 1.25 percent of the mortgage or $3,500. We qualify for and plan on withdrawing $20,000 each from our RRSPs under the Home Buyers’ Plan, and we have additional savings in cash for the down payment, but we are $15,000 short for the 25 percent down payment target. We are considering withdrawing extra money from our RRSP to come up with the extra $15,000 and plan on getting RRSP loans next year for the same amount to pay it back. This way we avoid taxes on the withdrawal.

It seems to me that the $3,500 cost of mortgage insurance is quite a lot for being $15,000 short for a 25 percent down payment. This is effectively an interest rate of 23 percent. The cost of an RRSP loan is only about 4 or 5 percent. Does this sound like a reasonable plan to you for coming up with the mortgage down payment. We both have good paying jobs and pay taxes in the highest tax bracket. – J.C., Vancver

 A – It’s an unorthodox approach and one that I would not normally recommend.

In effect, you are exchanging one type of debt for another –  you are reducing your mortgage principal by $15,000, while adding an RRSP loan of the same amount. The interest costs should just about offset, but the fact you intend to repay the RRSP loan quickly will save you money over the long run on that score.

You will also save the cost of the mortgage insurance, as you point out. This is a major plus.

However, there is a cost to this approach that you may not have considered.

First, be aware that a percentage of the amount withdrawn will be withheld at source. If the withdrawal is less than $15,001, the withholding rate is 20% (I always suggest that if you’re close to that figure, take out a little less to avoid any possibility of error).  Above $15,001, the rate climbs to 30%.

This means that when you withdraw $15,000 from your RRSP, you will actually receive only $12,000, leaving you with a shortfall of $3,000. If you can’t find this amount elsewhere, you’ll have to increase your RRSP withdrawal but to do so will put you into a 30% withholding bracket. So you would have to withdraw $21,500 to receive $15,000 (actually $15,050) after tax.

One possible solution to this problem: If you have separate, independent (not spousal) RRSPs, make withdrawals from each. You would need to withdraw $9,400 from each plan (total $18,800) to end up with the after-tax amount you need.

Let’s assume a best-case scenario  – you only need to withdraw $15,000 and can find the other $3,000 elsewhere. That means you will repay this $15,000 to the RRSP by March 1 2003 to avoid paying taxes on the withdrawal.

But suppose you had not made the withdrawal and paid the mortgage insurance fee of $3,500 instead. You would then be able to contribute $15,000 to your RRSP(s) and have that money generate a refund  –  not just offset a withdrawal. You say you are both in the top tax bracket. In B.C., the top marginal rate in 2001 was 45.7 percent. Using that figure, your $15,000 RRSP contribution would give you a tax refund of over $6,800. You are sacrificing that refund to save $3,500 in mortgage insurance costs. You may want to think it through again. – G.P.