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Young couple want it all, but will have to wait
ANDREW ALLENTUCK
From Saturday's Globe and Mail
In Vancouver, newlyweds we'll call Tom, 31, and Dawn, 29, have good careers. He works for an industrial company; she works for the City of Vancouver. They live in a condo, for which they paid 4,000, that has just about doubled in price to what they estimate is 0,000. They plan to have children within a few years. Also, they hope to buy a house in downtown Vancouver. The couple are juggling all that as well as Dawn's plan to extend her education. And they would like to retire when they are in their mid-50s. They want to do it all on salaries that currently total about 7,000, while paying off debts of 1,000.
"Should we sell the apartment and use the money for buying a small house, keep the apartment and rent it out and get a loan from the bank for the new house, pay down student loans as quickly as possible, invest in further education toward my master's degree or invest in RRSPs?" Dawn asks.
To work through the choices, Facelift asked Derek Moran, a registered financial planner who heads the Kelowna, B.C., office of Vancouver-based fee-only planning firm Macdonald Shymko & Co., to work with Tom and Dawn in order to sort out their options.
"They can't have it all," Mr. Moran says. "I feel sorry for young couples who have worked hard. Unfortunately, housing prices in Vancouver are so sky high that they either have to wait a few years until their finances strengthen or take what I perceive to be an unhealthy risk in building up even more debt."
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Vancouver couple want to do it all on salaries that currently total about 7,000, while paying off
Vancouver couple want to do it all on salaries that currently total about 7,000, while paying off debts of 1,000. (Jeff Vinnick/Globe and Mail)
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Tom and Dawn's biggest financial ambition is to move from their condo into a house that could cost 0,000. They would have 0,000 of equity in the house and would have to take a mortgage of 0,000. The additional debt could be financed at a current rate of 5.6 per cent, Mr. Moran notes. That would push up their present mortgage payments of ,600 per month to ,139 for a 24-year amortization that will have paid off their home by the time Tom reaches age 55, his target retirement age.
Their current amortization is 9.5 years, the planner notes.
The usual path would be to sell the condo and use the proceeds as a down payment for the house. However, rather than sell the condo, they have considered renting it out at what they estimate would be ,250 a month. Based on current carrying costs of taxes, monthly fees, and interest that total ,616, the condo would net ,384 a year. That is a return of 1.25 per cent a year, plus or minus capital appreciation, the planner says.
Keeping the condo and accepting the small annual return would mean that Tom and Dawn would have no down payment for the house they want to buy. Financing the house would involve taking on 0,000 of more debt on top of the 0,000 they already owe for their condo mortgage. Including their student loans, they would have to service 1,000 of debt, the planner explains.
Without a down payment, Tom and Dawn would have to apply for a high-ratio mortgage and would have to pay Canada Mortgage and Housing Corp. a ,125 fee, 2.75 per cent of the price of the house, which would be added to the mortgage, Mr. Moran notes.
The choice of keeping the condo or buying a house is not the only concern the couple have. Currently, including modest monthly savings, Tom and Dawn are spending about all of their monthly take-home pay of ,743. They do not have much capacity to take on another large mortgage, Mr. Moran says.
Dawn, a public service employee, earns pension credits. She would like to work part time next year and take a half-year course of studies that would eventually boost her income. But the move, which would cost her half a year's pay, would temporarily reduce her pension accumulation. She can make up the lost pay in four years and two months. With the additional credits, she would receive a 12-per-cent-a-year boost in her pension payments. Financially, taking the six-month course would be a good move, the planner says.
If she goes further to a master's degree, she would get an additional raise of ,000 a year at the cost of a year and a half of work, plus expenses. The payback period would be a good deal longer, however. Education, of course, is about more than money. But the degree would open up paths to more responsible jobs and higher pay.
Financing tuition for the master's degree would be problematic. Dawn has an ,000 student loan. If the loan is intact, it qualifies as a non-refundable tax credit.
On a calculation basis, 22 per cent of the loan is actually deductible. So on the loan's present cost of 7.75 per cent a year, the actual net cost is 6.04 per cent. But even after the cost reduction, it is still more expensive to carry than the condo mortgage, the planner notes.
Tom and Dawn would like to retire in their mid-50s. But it will be hard to manage on their present incomes, Mr. Moran says. At age 55, Dawn's pension is likely to be 60 per cent of her full-time salary, or about ,000 in 2006 dollars. She will not meet her plan's age factor for full payment until she is 60 years old, so she will have to choose between working longer or getting a smaller pension, Mr. Moran says.
The couple's registered retirement savings plans total ,000. Tom has ,000 of this amount in order to balance Dawn's public service pension. He will need 0,000 to 0,000 as a base within the RRSP to match Dawn's pension.
If Tom and Dawn add 0 a month to their RRSPs and grow assets at 6 per cent a year, then, assuming a 3-per-cent annual inflation rate, they will have 8,500 available when Tom is 55. This sum can finance withdrawals for all of Dawn's life expectancy plus five years at a rate of ,630 a year in 2006 dollars, the planner estimates.
If Tom works to age 55, he will earn 90 per cent of Canada Pension Plan maximum credits. If he starts drawing his pension at 60, his benefit will be reduced by 30 per cent. In 2006 dollars, his CPP payout will be ,385 a year. If Dawn works half time as a mom and a civic employee, her CPP will be half of Tom's. Adjustments for child-bearing years may push up her pension somewhat, the planner says.
If they remain in Canada, Tom and Dawn will each qualify for maximum Old Age Security, currently ,850 per person starting at age 65.
In the most optimistic terms, retirement at age 55 would leave Tom and Dawn with only a modest income. Retirement at age 60 for the couple is feasible, and postponing it to age 65 would make it possible for Tom and Dawn to have their house and a reasonably comfortable retirement, the planner says.
"I think the couple should hold off on buying the house until Dawn is done with her education and receives a pay raise," Mr. Moran says. "House prices may soften by then. They will also have more equity in their condo. In the meantime, reduce debts. A part of living well is living securely, after all."
"The house is the first priority, having children is second and retirement will obviously come later," Dawn says.
"We feel disappointed, but also enlightened. I might have to continue to work full time, even when I have children, in order to make all of our plans work out."
Interested in a free Financial Facelift? Then drop a line to the writer at 444 Front St. W., Toronto M5V 2S9 or
andrewallentuck@mts.net
Client situation:
Tom 31, and Dawn, 29, live in Vancouver.
Net monthly income: ,743.
Assets: Condo 0,000; RRSPs ,000; cash 0; car ,000; kayaks ,500.
Monthly expenses: Mortgage ,600; property tax 0; condo insurance 5; utilities 0; repairs 0; food and restaurants 0; RRSP 0; car fuel, repairs 0; auto insurance 0; clothing 0; medical 0; holidays, 0; entertainment 0; student loan payback 0; gifts and donations ; miscellaneous 0; savings 5. Total: ,743.
Liabilities: Mortgage 0,000; student loans ,000.
Quote: "I think the couple should hold off on buying the house until Dawn is done with her education and receives a pay raise. House prices may soften by then. They will also have more equity in their condo. In the meantime, reduce debts. A part of living well is living securely, after all."
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