Dave Chan/The Globe and Mail
Britney and Kevin have a problem that will be familiar to many Canadians – too much debt and not enough income.
They are 30 with two young children, ages 2 and 4, and a century home that recently required $100,000 worth of repairs. There is still much work to do.
"We're really concerned that a surprise roof leak or rotten siding in the next year will force us to put a major repair on credit again," Britney writes in an e-mail.
They want to set up an emergency fund but they are so burdened with debt they are not sure where the money will come from. Pressed as they are, they are still making modest contributions for their children's education and their own retirement.
Fortunately, Britney works for the federal government and so has a defined benefit pension plan that will pay her $4,583 a month at age 56, indexed 60 per cent to inflation. That amount would be reduced when she begins collecting Canada Pension Plan benefits. She earns about $84,700 a year before tax.
Kevin, who stays home to care for the children, earns about $8,400 a year working part time. Ideally, they would like to have a third child as well.
Is achieving their many and competing goals "possible while still having my husband remain a stay-at-home parent in a city where child care for our two kids would top $1,800 a month?" Britney wonders.
We asked Nancy Grouni, a financial planner at Objective Financial Partners in Toronto, to look at Kevin and Britney's situation.
What the expert says
Britney and Kevin are trying to do the right thing by saving for their retirement and their children's higher education, Ms. Grouni says, but need to revise their thinking.
"The truth is, if they continue on their current path, they will not only never pay off their debt, but they will also always have cash flow constraints," the planner says. The two are already making interest-only payments on two of their loans.
As for the emergency-fund-versus saving dilemma, "ideally, they would do both at the same time," Ms. Grouni says.
First, though, they should try to restructure their debt so they can pay it down as quickly as possible with the lowest rate of interest possible while freeing up much-needed cash flow. The planner suggests they talk to a mortgage specialist to see if they can borrow an extra $20,000 against their home as a home equity line of credit (HELOC), while at the same time lowering their mortgage rate, which is 4.8 per cent. (Five-year fixed rates are now 2.79 per cent to 2.99 per cent.)
They could then use the $20,000 HELOC to pay off their highest interest debt. Meanwhile, the lower mortgage rate would save them about $4,500 a year, less penalties, over the five-year period, and they could begin directing those savings toward paying down other debt.
For instance, they could use some of the HELOC money ($4,455) to pay off their outstanding income taxes, freeing up a much needed $370 a month. They could use the money remaining on their HELOC to reduce their unsecured credit line.
"This is a great one to pay off immediately since it is at 6.5 per cent, and they are making interest-only payments," Ms. Grouni says. Once the promotional rate on their credit card expires next spring, they can consolidate their credit card balance with the unsecured line of credit at 6.5 per cent, she adds. At a rate of $500 monthly, it would take about five years to pay off.
If they were to plan for another child at age 35 or 36, when the line of credit would be paid off, they could then direct their money to paying off their HELOC sooner, the planner says.
With their debt issues on track, they will have about $2,700 more a year to tuck away in their tax-free savings accounts for emergencies. In addition, the planner recommends they redirect their retirement savings "at least in the short term" to their TFSAs, which would give them another $1,500 a year for emergencies.
"As an emergency backup, they will also have increasing room on their HELOC as it gets paid down," the planner says.
To further build cash flow, Kevin and Britney should consider trying to increase their family income. For example, Kevin could find a job working evenings and weekends, when Britney would be home. If he could bring his income up to $13,000 to $15,000 a year, it would give them some breathing room to help relieve their cash-flow crunch.
Client Situation
The people
Britney and Kevin, both 30, and their two children.
The problem
How to tackle their debts, establish an emergency fund and save for the future all on one salary.
The plan
Try to borrow an added $20,000 against their home's value, which would allow them to pay down higher-interest debts, lowering their monthly payments. Use the freed-up credit line and the extra cash flow as an emergency fund. Put RRSP contributions on hold for now and consider finding some way to raise family income.
The payoff
Relief from the worries caused by their cash flow crunch and the comfort that comes with a clear, long-term financial plan.
Monthly net income:
$5,875 (variable)
Assets: Cash in bank $800; registered education savings plan $7,850; registered retirement savings plans $12,070; estimated present value of Brittney's pension $55,360; residence $450,000. Total: $526,000.
Monthly disbursements:
Mortgage $1,440; property tax $270; utilities, home insurance, maintenance $495; transit $80; groceries $500; child care $195; clothing $30; credit line $155; HELOC $255; income tax $370; credit cards $340; gifts $30; vacation, travel $200; personal discretionary $235; life, disability insurance $120; drugstore, dentists $30; telecom, TV, Internet $180; RRSPs $125; RESP $200; her pension contributions $600. Total: $5,850.
Liabilities:
Mortgage $252,000; HELOC $88,345; unsecured line of credit (student loan) $29,400; credit cards $12,130; tax bill $4,450. Total: $386,325.
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Some details may be changed to protect the privacy of the persons profiled.