"Hans" and "Gretta" want a home, kids, a pet and, one day, their own business.Sarah Dea for The Globe and Mail
Hans, 30, and Gretta, 28, are university educated and debt-free. Now, with their hopes and dreams drawing nearer - first home, children, a dog or cat, and eventually their own business - they're in a quandary.
Hans works in information technology while Gretta is in school, planning to start work this spring. They plan to move from Toronto to the Kitchener-Waterloo area of Ontario, where they can buy a house for $300,000 to $375,000.
"We have been fairly diligent savers," Gretta writes in an e-mail, "renting modest apartments, buying a used car, and only splurging on one four-month vacation in 2007."
As a result, they have an enviable choice: Should they take out a mortgage loan to buy a modest home, or should they scrape together every last penny they have saved, combined with gifts from relatives and pay all cash?
"Without a mortgage, the interest we could save would be a plus," Gretta adds, "but it would leave us with virtually zero cushion behind us."
We asked Stephen Osborne, a financial planner at E.E.S. Financial Services Ltd. in Markham, Ont., to look at Hans and Gretta's situation.
What the expert says
There is no right answer, Mr. Osborne says.
"I put this question to other members of the consulting staff at E.E.S. - with more than 200 years of combined experience - and the decision was not unanimous." Psychology is as important as the numbers, the planner says.
"Numbers can tell you how much interest you can save by paying off your mortgage, but they can't speak for what the clients are thinking when they say it would leave them with 'virtually zero cushion behind us.'"
Still, given how low interest rates are at the moment, Mr. Osborne advises Hans and Gretta to take the plunge, making a down payment of 20 per cent of the purchase price of their new home and borrowing the balance. With 20 per cent down, they would not have to pay mortgage insurance fees. This would leave them with a comfortable cushion.
As Gretta seems to realize, a cushion is important because their plans include uncertainties "that can be aided by having a reserve of assets or a stash."
Mr. Osborne lists four ways the couple might benefit from this approach. Moving from an apartment to a house, they will need to furnish the new home and might need or want to do some work on the place before they move in. Second, the costs of running their home and having children might prove more than they expected.
If they decide to test out self-employment, they can use their savings and investments either as a source of capital for their new business or to cover living expenses until their business can generate sufficient cash flow, Mr. Osborne says. Finally, their savings can be used to invest in other opportunities.
"Diversification is a motherhood element of financial planning," especially when some of their investments are paying a higher rate of return than they would pay for mortgage interest. Besides, if they waited until they started their own business and found they had to borrow, "banks might perceive their incomes to be less stable and not be as willing to lend to them."
If they bought a $350,000 house, they would need a $70,000 down payment. They could each withdraw $25,000 from their registered retirement savings plans under the federal Home Buyers' Plan. Gretta's $10,000 guaranteed investment certificate would be another logical source of funds because it pays very low interest, the planner adds.
"Between existing investments and anticipated gifts from relatives, they would be able to raise the down payment," Mr. Osborne says. He suggests they hold some of their higher-yielding investments (bank shares) in their tax-free savings accounts and their lower-yielding, emerging funds outside of the TFSA. In a squeeze, they should draw emergency funds from their non-registered holdings (outside both their RRSPs and their TFSAs) first.
"If they do end up needing to make a withdrawal from the savings in the TFSA, they can do so without triggering any taxable income and would be able to repay their TFSA … the year after the withdrawal," the planner notes.
CLIENT SITUATION
The People
Hans, 30, and Gretta, 28
The Problem
Whether to pay cash for a first home, which would require emptying out their bank accounts and relying on gifts from relatives, or finance the home purchase with a mortgage loan.
The Plan
Use savings to make a 20-per-cent down payment and borrow the rest.
The Payoff
A cash cushion that will give them the flexibility to meet future challenges, including going into business for themselves.
Monthly net income
$5,600 Assets
Bank accounts $20,000; GIC $10,350; stocks $134,000; her TFSA $15,250; his TFSA $15,000; her RRSP $26,000; his RRSP $27,000. Total: $247,600. Monthly disbursements
RRSP contributions $1,100; groceries, dining out $500; clothing, dry cleaning $75; drugs, dental $25; tech tools $25; gifts $65; rent $1,100; house insurance $35; telecom, cable, Net $170; vacations $300; entertainment $40; courses, hobbies $500; auto expense $330; public transit $120. Total: $4,385. Savings capacity: $1,215. Liabilities
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