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Financial Facelift

Tackling a debt that refuses to die Add to ...

For a decade now, Stella and Stan have been dogged by a line of credit that just never seems to go away.

“We make a lot of money. We live a very ascetic life. Why can’t we pay down our line of credit?” Stella laments in an e-mail. The debt isn’t big – $20,000 on average – but it is becoming oppressive.

That’s because they are moving from suburban Kelowna to a more central location close to their children’s school and will need to take on more debt. Making matters worse, “the housing market here is dead,” Stella says, so it may take some time to sell their existing home.

Stan is 43, Stella 37. They have two children, 8 and 4.

After wrestling with the decision for months, they took the leap to a more expensive house in September – the purchase price: $645,000. The unconditional deal is set to close at the end of November. They hope their existing house will sell for $550,000 to $570,000.

“I hated to put my family’s happiness on hold,” Stella says of the move, “yet I don’t want to accumulate a debt that we may never recover from.”

Fortunately, both of them work at a local post-secondary institution, giving them a family income of $208,000. They own a rental property in Ontario that is barely breaking even. Both have defined-contribution pension plans, which resemble registered retirement savings plans. As well, Stan has a defined-benefit pension plan from a previous employer that will pay about $26,000 a year starting at age 57. They aim to retire when they are 65.

Their goals are to pay off their debts as soon as possible, save for their children’s post-secondary education and amass enough wealth to retire with an after-tax income of $120,000 a year.

We asked Warren Baldwin, regional vice-president of T.E. Wealth in Toronto, to look at Stella and Stan’s situation.

What the expert says

Stella and Stan face some challenges, but they have time to make things work, Mr. Baldwin says. Given their debt and the children’s future education costs, they will be hard pressed to save anything beyond their current pension and registered retirement savings plan contributions. They are contributing slightly more than $35,000 a year to their work pension plans and RRSPs, including the 10-per-cent portion their employer contributes. With a 5-per-cent return on investment and a 2-per-cent inflation rate, their pension/RRSP assets will total $2.7-million by the time Stella is 65, including growth and the indexation of contributions over the next 27 years, the planner calculates.

They will also need to save for their children’s education, although the children may benefit from discounted education costs if they attend the university where their parents work.

“Regardless, they certainly have plenty of places to allocate funds over the next 27 years.”

Stella and Stan’s new mortgage is about $315,000, compared with $145,000 for the old one. The new amount includes commission costs to sell the old property along with moving expenses, minor renovations to the new property and closing costs.

“With a $300,000 mortgage, if interest rates rise by two percentage points, the payment will increase by $500 a month,” Mr. Baldwin notes. His calculations assume their existing house will sell soon and they will not be left carrying two properties for any length of time. Their child-care costs have dropped by $1,000 a month this fall because the younger child has started kindergarten, and that money will go toward the higher mortgage payment.

While the Ontario rental property is not making any money and “likely will continue to run quite close to the line for many years into the future,” if they can pay it off and its value rises in line with inflation, it could eventually give them another $500,000 to help fund their retirement needs, he adds.

They may need it. If they were to spend their target $120,000 a year after they retired, they would run out of savings by the time Stella is 78, Mr. Baldwin calculates. If they do not have a cushion from the sale of the rental property, they will have to cut their target spending to $89,300 a year. Then their capital would last until Stella was 90. Even with the rental-property cushion they can only afford a retirement lifestyle of $105,000 per year.

“The estate for her would be the value of her home.”

To achieve their goals, Stella and Stan will need to draw up a strict budget and apply themselves diligently to paying down their debts, the planner says. He suggests they review their life insurance to make sure it takes into account their higher debts. As well, “one risk area that seems to be quite serious for them is the fact that they have no wills or powers of attorney.”

Client Situation

The people: Stan, 43, Stella, 37, and their two children, 8 and 4.

The problem: Can they afford their new and more expensive home in central Kelowna without running up a dangerous debt? And will they ever be able to pay off that line of credit?

The plan: Draw up a budget that includes some serious debt repayment, assume no increase in retirement savings from the current level, build RESPs for the children and prepare to live a bit more modestly when they retire from the university.

The payoff: More control over their financial future and a secure and debt-free retirement.

Monthly net income: $11,400.

Assets: New home $645,000; bank accounts $3,000; RRSP $33,000; employer pension plans $272,000; rental property $300,000; present value of his DB pension plan $200,000. Total: $1.45-million.

Monthly disbursements: New mortgage $1,865; property tax $235; utilities $420; insurance $190; maintenance, gardening $150; vehicle insurance $330; fuel $350; maintenance, parking $165; groceries $1,200; child care $500; clothing $200; loan payments $1,000; gifts $100; charitable donations $25; vacations and travel $500; drinking and dining $150; beauty $150; entertainment $150; pets $100; sports, hobbies $100; drugstore $80; health, dental insurance $150; life and disability insurance $105; telecom, Internet, cable $180; RRSPs $600; educational needs $460; professional association $25; group benefits $95; employee portion of RPPs $865. Total: $10,440.

Liabilities: New mortgage $315,000; rental property mortgage $250,000; line of credit $21,000; student loan $1,500. Total: $587,500.

Special to The Globe and Mail

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