Rafal Gerszak for The Globe and Mail.The Globe and Mail
Beth is 31, single again and eager to chart a new financial course. Not long ago, she started a new job in the forest industry with higher pay, so her future's looking bright.
She has a condo in Alberta that she bought at the peak of the province's real estate boom in 2007 and that she rents out for near break-even. Last year, she bought a modest home in British Columbia.
"I have worked really hard to get where I am and my career is starting to take off," Beth said in an e-mail. She wants to ensure her financial independence "and make some smart moves with my money while I am still relatively footloose and fancy-free!" She has two mortgages, lines of credit and other consumer debt that she wants to pay down.
"Should I aggressively pay down debt or put more money into my RRSPs and TFSA?" she asks. She wants to sell the Alberta condo but would likely lose money if she did so now. She's also thinking of expanding her B.C. home and maybe – just maybe – buying a cabin or some land in the Cariboo-Chilcotin area of B.C.
We asked Anand Sharma, investment specialist at the North Delta community branch of VanCity/Credential Asset Management Inc. of Vancouver, to look at Beth's situation.
What the expert says
Beth appears to have a savings capacity of $700 a month on top of $350 a month she is contributing to her RRSP, Mr. Sharma notes. But she may be overlooking some expenses, such as vehicle replacement, the money she sends to her sibling periodically or the recent special assessments on her Alberta condo.
With 96 per cent of her assets in real estate, Beth is "highly exposed to the risk of downturns in the real estate markets," the planner says. She has about $37,800 in debts over and above her mortgages and very little in the way of savings. "Combined with her heavy weighting in real estate, a lack of liquid assets could leave Beth's financial future exposed to undue risk."
Mr. Sharma suggests Beth first build an emergency fund of $10,000 to $20,000, enough to cover three to six months' expenses. She could do this by tucking some of her surplus into a tax-free savings account.
She should then tackle her consumer debt. "One possible alternative is to consolidate her unsecured debt with another mortgage using her rental property as security," Mr. Sharma says. The idea would be to lower her borrowing costs, making it easier for her to pay off the loans.
As to her long-term goals of expanding her house and buying a country property, the planner is cautious. Beth may find she can do one or the other, but perhaps not both. He suggests she sell the Alberta condo and pay down her debts before she embarks on a renovation of her home.
Beth wonders whether it would make more sense to pay down the mortgage or save for retirement. Mr. Sharma looks at the numbers:
If she invested an extra $350 a month in her RRSP, and reinvested her tax refund in her RRSP as well, the future value of her RRSP (when the mortgage was paid off) would be $376,420. She would have paid $101,555 in mortgage interest and the mortgage would be paid off in 382 months, Mr. Sharma calculates. That assumes a 4.5-per-cent annual return on her investments.
Alternatively, if she took that $350 and used it to pay off the mortgage in full, then redirected the $350 – plus what she had been paying on the mortgage – to an RRSP for the remainder of the original mortgage amortization period, the situation would look like this: Her RRSP value would be $304,634, she would pay $59,878 in mortgage interest and the mortgage would be paid in 235 months, Mr. Sharma says.
"Financially, paying down the mortgage instead of contributing $350 monthly to her RRSP yields a lower future RRSP balance ($71,786 less)," the planner says. "But it also results in paying less mortgage interest ($41,677 less).
"Remember that the RRSP balance is eventually taxed when it's withdrawn. And the mortgage payments are being made with dollars Beth has already paid tax on," he says. "So the extra RRSP balance may not be worth these higher interest payments."
CLIENT SITUATION
The person
Beth, 31
The problem
Whether to pay down debt or save for retirement, sell or keep the rental condo, add on to her home and eventually buy a rural retreat without jeopardizing her financial future.
The plan
Temper her ambitions until the debt is paid down. Build an emergency fund, consider refinancing consumer debt to pay it off more easily, consider selling the condo. Focus on paying off the mortgage on her principal residence.
The payoff
Lower interest payments over time, a rainy day fund to cushion any unforeseen events and the security a mortgage-free home brings.
Monthly net income
$4,825
Assets
TFSA $900; RRSP $17,000; employer pension plan $500; residence $250,000; condo $250,000. Total $518,400
Monthly disbursements
Mortgage $820; utilities $160; property insurance $65; maintenance $100; auto expenses $380; food, clothing $300; loan, credit card payments $1,100; gifts, charity $100; pets $50; personal $60; vacation, travel $200; entertainment, dining out, hobbies, subscriptions $250; telecommunication, TV $190; RRSP $350. Total: $4,125. Savings capacity: $700.
Liabilities
Home mortgage $212,000; rental condo mortgage $163,000; credit lines $20,900; credit cards $1,900; loan from parents $15,000. Total: $412,800.
Special to The Globe and Mail
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