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Facelift. Jennifer Roberts for the Globe and Mail
Facelift. Jennifer Roberts for the Globe and Mail

Financial Facelift

Easing off on the mortgage paydown Add to ...

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Lyla and Sam feel they have been living too long with debt.

They have a mortgage that never seems to go down, a line of credit that keeps going up, credit card debt they can't seem to pay off and two children, a boy, 17, and a girl, 15, who will soon be going to university.

"How do we help them financially?" Lyla asks in an e-mail.

Both Sam, who is 50, and Lyla, 49, have steady jobs, he in information technology and she as an administrative assistant. They pull in about $90,000 a year in income but they can't seem to get ahead.

"We are always in the red and pay a lot of interest and overdraft charges," she laments. They've had to dip into their line of credit to make ends meet, and when it gets too big they add it to their mortgage.

"I'd just like enough money at the end of the month to go out and have a nice dinner with my husband," Lyla said in an interview.

"I am not sleeping well over our financial situation. I worry constantly and wonder, if we continue the way we are going, where will we be in 10 years?"

We asked Warren MacKenzie of Weigh House Investor Services, formerly Second Opinion Investor Services, to look at Sam and Lyla's situation. The mortgage is indeed the problem, Mr. MacKenzie discovered, but not in the way Lyla and Sam think.

What our Expert Says There is a huge difference between financial security and financial independence, Mr. MacKenzie says. Financial security comes when people understand their financial situation and feel confident that they are doing things right and that they will be able to retire comfortably.

Sam and Lyla do not have enough money to retire just yet, so they are not financially independent. Because they worry constantly about their debts, they also have no financial security.

They'd feel a lot better if they understood their situation, he says.

"They are concerned because they believe that their short-term cash problem is indicative of a serious long-term problem, but it is not."

The problem is the speed with which they are paying off their mortgage. When they switched from a fixed-rate loan to a floating-rate one with a much lower interest rate - 1.25 per cent currently - they kept their payments high, hoping to repay the mortgage in full in 10 years. Their eagerness to be debt-free is costing them.

The result is they are paying $1,475 a month - $690 a month more than the $785 they are required to pay. If they made the minimum payments, the mortgage loan would still be retired by the time they were, Mr. MacKenzie says, even though their payments will rise in line with interest rates.

Because they have set their sights so high, "some juggling is often required to have the money available at month end to make the mortgage payment," the planner observes. Sometimes, in order to make ends meet, they borrow against their line of credit.

Sam and Lyla also worry that they will not be able to pay for a university education for their two children. Mr. MacKenzie's solution: Let the children help pay for their own education through grants, loans and part-time work if necessary. They'll appreciate their education more if they do, he says.

If Lyla and Sam pay half of the cost of eight years of university education at an average cost of $16,000 per year, then their share of the cost (ignoring inflation) will be $64,000, he says.

They already have $19,000 in an RESP, to which they are contributing $200 a month. Assuming a 5-per-cent rate of return and taking into account the amount the government kicks in to RESPs, they will have enough for the $64,000 cost if they put an additional $250 per month into the RESP, Mr. MacKenzie figures.


First, though, they should divert money from the extra mortgage payment to pay off their high-interest credit card balance of $3,000. Then they should begin tucking an extra $250 a month into the RESP, using the balance to pay down their line of credit.

"By applying all cash payments to the debt that bears the highest interest rate, they will eliminate total debt faster," he notes.

Once the children's schooling is paid for, it's clear sailing. The couple can use the money they had been putting into the RESP to contribute more to their RRSPs, which will continue to grow even after they have retired.

As municipal employees, if Sam and Lyla continue to work until age 65, they will retire with fully indexed, defined-benefit pensions that will allow them to not only maintain but to actually improve their lifestyle, Mr. MacKenzie says.

In retirement, with their mortgage paid in full, the couple will be spending 50-per-cent less than they are now, he estimates. With the Canada Pension Plan, Old Age Security, their work pensions and investments, their retirement income will be about $75,215 (with inflation factored in), which adds up to almost 80 per cent of their current income.

"With expenses cut in half and income reduced by only 20 per cent, they are going to be better off in retirement than they have been at any time since they were married."

They'll still have plenty to leave their children. Assuming normal life expectancy and a reasonable rate of return, their financial projections show that they will be leaving their children an estate of about $1.5-million in inflation-adjusted dollars. That includes the house and their investment portfolio.

Mind you, this rosy picture could change for the worse if either of them died at an early age, the planner cautions. The remaining spouse would have to get by on one pension plus a portion of the other's pension, so income could be reduced more than expenses. As well, their own pension, plus a 60-per-cent survivor's benefit, could push the surviving spouse into a higher tax bracket, possibly resulting in a clawback of OAS.

Mr. MacKenzie says they could protect themselves by purchasing additional life insurance.

As for their $35,000 RRSP, he advises the couple to switch their investments to a lower-risk asset mix from the 70-per-cent equities and 30-per-cent bonds they hold now.

Their current mix is a growth strategy designed to make a long-term average rate of return of about 8 per cent, he notes. The financial projections show that they can achieve all of their goals with a balanced, less risky strategy of 50-per-cent equities and 50-per-cent bonds.

"Given that they do not need a high average rate of return, and given that the markets are overvalued by some measures, this might be an appropriate time to take profits and go to a lower risk portfolio."

Their investment assets are in mutual funds with deferred sales charges. Because of the high management expense ratios, over the rest of their lifetime their portfolio could well underperform a portfolio of exchange-traded funds with the same asset mix by about 1 per cent a year, Mr. MacKenzie says.

"On their modest portfolio of $35,000, underperformance of 1 per cent per annum would reduce the value of their account by more than $50,000 over their expected lifespan of 35 years."

Even with the higher fees, mutual funds might be appropriate for a small investment portfolio, but as their portfolio grows, as it will in retirement, they should consider lower cost alternatives such as ETFs, he says.


The People:

Sam, 50, Lyla, 49, and their two children, aged 17 and 15.

The Problem:

Not having enough money at the end of the month to pay all the bills and contribute to their savings plans.

The Plan:

Stop making extra payments to the mortgage and use the money instead to pay off credit card debt. Once that is paid, make regular contributions to RESP and apply balance to line of credit.

The Payoff:

Peace of mind, both now and in future, and money to help their children through university.

Monthly after-tax income:



House $550,000; RRSPs $35,000; RESP $19,000. Total $604,000

Monthly Disbursements:

Mortgage payment $1,475; property taxes $420; line of credit payment $300; RRSP contribution $100; RESP contribution $200; car and home insurance $208; life insurance $140; heat, hydro, water $292; credit cards $200; food $645; clothing and household goods $400; telephone, Internet and cable $159; cellphones $100; club memberships $58; pet supplies $20; monthly donation $25; dining out, gifts $300; gasoline $165; miscellaneous $193. Total $5,400


Mortgage $202,000; line of credit $44,000; credit card debt $3,000. Total $249,000

Special to The Globe and Mail

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