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Financial Facelift

Tackle other debt, pay down the mortgage later Add to ...

Justin is ambitious and single-minded. He wanted a condo in Toronto, so he borrowed from his mother and raided his RRSP to come up with a down payment.

Now he wants to pay down the mortgage as quickly as possible. No wonder. He is 34, single, and has a mountain of debt: a $236,000 mortgage loan at a floating interest rate, now 2.3 per cent; $25,000 borrowed from his registered retirement savings plan under the federal government's Home Buyers' Plan; and $6,000 still owing on the loan from his mother.

To help with things, Justin has taken in a roommate ($800 a month), rented out his parking space ($75 a month) and taken a part-time job ($600 a month before tax) to top up his regular paycheque. This leaves him with about $4,575 a month after tax - a tidy sum given his low living costs.

Justin has a small amount of money tied up in a pension with a previous employer, the Ontario government. He wonders whether he should leave it there or shift it to a locked-in retirement account. He also wonders whether he can use it to repay the home buyer's loan. He still has some money tucked away in mutual funds in his RRSP and would like to continue to invest for his eventual retirement in about 30 years, but he's having trouble getting his priorities straight.

"I don't have a strong financial background so I need some guidance with future strategies," Justin writes in an e-mail.

We asked Kurt Rosentreter, a senior financial adviser and chartered account at Manulife Securities Inc. in Toronto, to look at Justin's situation.

What the expert says

Justin has a good head on his shoulders, but he has taken some risks, Mr. Rosentreter says.

"My first message is that he should be in a mad rush to reduce his enormous debt load."

Justin's condo purchase was likely sparked by unusually low interest rates. He didn't stop to ask the tough questions, Mr. Rosentreter says. What if interest rates triple over the next five years, or condo maintenance fees rise by 15 per cent a year, or the roommate moves out and Justin loses his job? What if he gets married and has children and has new costs that he can't afford because of the size of his mortgage?

Still, the mortgage is not the place to start. Justin's first target is the loan to his mother, on which he is paying 6-per-cent interest, followed by the home buyer's loan. "Pay it back in five years," Mr. Rosentreter says. Borrowing from retirement savings to fund current needs "is not good financial planning," he adds. At that point, Justin can begin focusing on the mortgage.

The pension money from the previous employer cannot be used to repay the home buyer's loan. Mr. Rosentreter suggests Justin leave it with the government until he turns 65 because it is safe there and indexed to inflation - "a sweet benefit that is worth a lot." Its current value is $10,790.

In his eagerness to pay off his debts, Justin has neglected to build an emergency fund, the planner notes. "He should hold three months worth of paycheques in a high-interest savings account." Because he is single and self-supporting, he may also want to explore disability insurance if he does not already have it with his employer, Mr. Rosentreter says.

Justin hopes to retire in 30 years or so, but he has no company pension plan. Assuming he needs $30,000 a year after tax to live (excluding Canada Pension Plan and Old Age Security payments), he will need to save $13,500 a year, assuming a 5-per-cent rate of return annually, to accumulate the $900,000 or so it will take to provide that retirement cash flow, the planner says.

As it stands, Justin's living expenses appear far too low. If he bought a car, that would take a big chunk of money to buy and operate - and he would lose the rental from his parking spot. If he decided to get married, his expense picture would change entirely.

"If interest rates rise, he could be squeezed out of affording his home," Mr. Rosentreter says. "Combine this with a real estate correction that could hit condos far worse than any other kind of home, or job loss or disability, and he could be substantially set back."



Client situation



The Person:

Justin, 34.



The Problem:

Deciding which loans to pay first and whether to pay down the mortgage or save for retirement.



The Plan:

Build an emergency fund. Pay off the loan to his mother, then repay the money taken from his RRSP under the Home Buyers' Plan. After that, concentrate on the mortgage and simultaneously save for retirement.



The Payoff:

Manageable debt and the flexibility it brings, and eventually a secure retirement.



Monthly net income:

$4,575.



Assets:

Condo $317,000; bank account $500; mutual funds $14,700. Total: $332,200.



Monthly disbursements:

Food and eating out $250; clothing $50; personal allowance (socializing) $350; miscellaneous $100; mortgage $1,100; property taxes $165; condo fees $390; house insurance $20; utilities $55; telecom, cable $90; vacations $250; bus, subway $150; donations $10; gifts $25. Total: $3,005. Savings capacity: $1,570.



Liabilities:

Mortgage $235,945; loan to mother $6,000; home buyer's loan $25,000. Total: $266,945.



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