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financial facelift

Lisa has built up some equity in her Greater Toronto Area condo townhouse and is hoping to move up to a roomier house.Mark Blinch/The Globe and Mail

Lisa is 45 and single with no dependants. She has a good, white-collar job earning $75,000 a year plus a bonus. She also has a work pension plan.

Lisa has built up some equity in her Greater Toronto Area condo townhouse and is hoping to move up to a roomier house, perhaps a semi-detached. Her current home is valued at $565,000. Against this, she has a $325,000 mortgage and a line of credit.

"When I sell my home, I will realize a (net) profit of about $180,000," Lisa writes in an e-mail. "Would it be wise to use the majority of the proceeds toward a down payment, or to put 20 per cent (about $120,000) down and invest the rest?" she asks. That assumes a $600,000 purchase price.

Lisa also has questions about her investments. She has some company stock and registered accounts with three different financial institutions. She wonders if it would make sense to consolidate her various accounts and sell the company stock that she owns.

We asked Matthew Sears, a consultant at T.E. Wealth in Toronto, to look at Lisa's situation. Mr. Sears holds the chartered financial analyst (CFA) and certified financial planner (CFP) designations.

What the expert says

Lisa is looking to sell her current home and upsize to a bigger one within the next year for $600,000, Mr. Sears says. Lisa plans to retire in 20 years, when she will be entitled to a pension of $32,560 a year.

First, the planner looked at whether Lisa can actually afford to buy a more expensive house. Lisa estimates she would have about $180,000 as a down payment for the new house purchase. This would leave her with a mortgage of $420,000. The mortgage, amortized over 25 years at 2.94 per cent, would cost $1,975 a month, about $600 more than she is paying now, Mr. Sears says. (Lisa subsequently has raised her monthly mortgage payments by $325 a month to $1,700.)

"Based on Lisa's currently monthly cash flow, this would be stretching her budget," Mr. Sears says. Lisa could divert her monthly RRSP and TFSA contributions ($400) to the mortgage payment, but this would put her retirement spending goal of $50,000 a year after tax out of reach, he adds. Even then, it would not make up the entire increase in mortgage payment.

Another risk factor is the mortgage would not be paid off before Lisa retires. Shortening the amortization period to 20 years, when Lisa plans to retire, would raise the monthly payment to about $2,315, a difference of $940. As well, a larger house would come with higher property taxes, heating costs and maintenance, he notes.

Based on a $6,250 gross monthly salary, a 2.94-per-cent mortgage rate, a 25-year amortization rate and the same monthly expenses Lisa currently has, the most she can afford to borrow is $360,000, Mr. Sears calculates.

If her annual bonus is included, the maximum mortgage would be $414,000. "The risk associated with using an amortization of 25 years is that Lisa would be carrying the mortgage into retirement," the planner says.

Mr. Sears did a sensitivity analysis to see what the effect of higher interest rates would be. If the mortgage rate is increased to 4.99 per cent, for example, the size of loan Lisa could afford falls even further. Assuming a 20-year amortization would reduce the amount Lisa could borrow to between $250,000 and $308,000. This would rise to between $297,000 and $350,000 if her bonus is included.

"The reality is that purchasing a house for $600,000 is most likely out of reach for Lisa right now," Mr. Sears says.

If Lisa does decide to sell her current home and buy a new one, the entire proceeds from the sale, after closing costs and paying off her line of credit, should be used for her down payment.

Next, the planner looks at Lisa's investments. He suggests she consider consolidating her assets with one financial service provider. "Most likely the three financial institutions aren't looking at what the other is doing when it comes to managing her overall investment portfolio."

By consolidating, Lisa can benefit from better management of her overall asset allocation under one adviser. This will help her be more disciplined in her approach to her portfolio, rebalancing when necessary and sticking to her optimal asset allocation. In addition, consolidating often lowers costs.

Lisa would also benefit from simpler reporting and administration, only having to meet with one adviser throughout the year, and her statements would be coming from one source.

Lisa should aim for a diversified portfolio of low-cost mutual funds and exchange-traded funds that not only invest in different asset classes but also in different geographic regions, the planner says. Any funds she might need in the near future should be invested in low risk, liquid investments such as term deposits.

Lisa is thinking about selling $10,000 worth of her company stock and wonders what to do with the proceeds. She could use it to pay down her line of credit or mortgage, Mr. Sears says. Alternatively, she could contribute it to her RRSP and invest the funds as part of her overall investment strategy.


Client situation

The person: Lisa, 45

The problem: How to finance the purchase of a bigger home and organize her investments more efficiently.

The plan: Think twice about buying a more expensive house because it would stretch her cash flow and have her carrying a mortgage after she retires from work. Consolidate her investment accounts.

The payoff: A more secure retirement with less risk.

Monthly net income: $4,825

Assets: Cash and short-term investments $20,700; stocks, mutual funds $13,300; TFSA $4,700; RRSP $81,000; estimated present value of defined benefit pension plan to date $98,055; residence $565,000. Total: $782,755

Monthly disbursements: Mortgage $1,375; condo fees $200; property tax $220; utilities, insurance, security $200; transportation $390; groceries $100; clothing $50; line of credit $85; gifts, charitable $45; vacation, travel $50; grooming $40; dining, entertainment $75; drugstore, vitamins $20; telecom, TV, Internet $265; RRSP $350; TFSA $50; pension plan contributions $170; group benefits $710. Total: $4,395. Unallocated surplus: $430

Liabilities: Mortgage $325,000 at 3.44 per cent; line of credit $40,000 at 2.7 per cent. Total: $365,000

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Some details may be changed to protect the privacy of the persons profiled.

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