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financial facelift

-Darren Calabrese/The Globe and Mail

Eric and Ilsa put lifestyle ahead of financial concerns but it has put them in a bit of a bind. He is 41 and a physician, she is 39 and a dentist.

They have five children, ranging in age from less than a year to 9, all of whom will go to private school. They have substantial earning power – although Ilsa is on mat leave at the moment – but Eric chooses to work for less money than he could.

They are living rent free in a relative's house (they pay taxes, utilities and upkeep) and "regret not having bought a house years ago," Eric writes in an e-mail. Houses in their Vancouver neighbourhood have doubled in price in the past two years. The house where they live is going up for sale soon, so they need to move quickly.

Last fall, they bought a building lot for $1.1-million and are planning to build a house large enough for their family and a live-in nanny. But with a combined income of $360,000 ($450,000 when Ilsa returns to work) and an $800,000 mortgage, can they afford the builder's $1-million price tag? Who will lend them the money?

"Two professionals should be able to afford a modest house, but we can't get the numbers to work and would appreciate some help," Eric writes. He earns $200,000 a year working in a medical clinic. But his real love is teaching, which he does one day a week at a university; this earns him $100,000 a year.

"I have no pension whatsoever, but like my parents, colleagues and mentors, I love my work and plan to keep going well into my 80s, so retiring is not a big concern, just living," Eric writes.

We asked Warren MacKenzie, principal at HighView Financial Group in Toronto, to look at Ilsa and Eric's situation.

What the expert says

Eric and Ilsa's expenses are likely the highest they will be and they have not yet seen the long-term benefit of their education and the income it will generate for the rest of their lives, Mr. MacKenzie says. So, with five young children and a nanny, they're feeling strapped for cash.

"It is financially possible for them to do the things that are important to them, although by doing so, they will run a cash flow deficit of $50,000 a year until the children leave home," Mr. MacKenzie says. Over time, their annual deficits will add up to more than $1-million in additional debt. They can build their home, but they have to make a choice. Either Eric works one more day a week in the clinic, or they run up substantially more debt.

Eric and Ilsa are fortunate because their parents are willing to put a home equity line of credit on their own home to extend them the $1-million they need to build, and to finance their annual deficit, the planner notes.

"However, there is a danger in accumulating so much debt because things don't always work out as expected," the planner says. "In this case, it is unwise especially when the cash flow problem could be easily solved," Mr. MacKenzie says.

"If Eric is willing to work one more day a week in the clinic, they can live within their means and still afford to build the new home using a HELOC with the parents' home as security," Mr. MacKenzie says. He would be bringing in $500,000 a year. Once Ilsa returns to work part-time, she hopes to make $150,000 a year. Their first priority once the house is built should be to pay off the mortgage.

But Ilsa and Eric face a more immediate risk. With five children and a big debt load, they have neither life nor disability insurance. Their long-term financial security is dependent mainly on Eric's high earning power.

"If Eric died or became disabled, then Ilsa would be left with five children and serious financial problems," Mr. MacKenzie says. "This is a dangerous and unnecessary risk." Eric should have term life insurance to provide his spouse with an income if he died and disability insurance in case he was unable to work. Eric should shop around for the best 20-year term life policy, and a disability policy that would pay $10,000 a month. The cost of these policies would be in the range of $600 to $800 a month, the planner says.


Client Situation:

The people: Eric, 41, Ilsa, 39, and their five children.

The problem: Can they afford the lifestyle they've chosen and the $1-million price tag to build a new home?

The plan: Either they run up a big deficit over the years or Eric earns more money by working a second day a week in the clinic. Eric gets some insurance right away.

The payoff: A road map to a stable and secure financial plan.

Monthly net income: $25,000

Assets: Cash in bank $6,000; his RRSP $180,000; residential building lot $1.1-million. Total: $1,286,000

Monthly disbursements: Mortgage $3,800; property tax (both properties) $1,000; utilities $490; insurance $90; maintenance, garden $190; transportation $800; groceries $2,000; clothing $520; children's activities $1,000; tuition $5,400; summer camp $600; child care $2,800; gifts, charitable $320; vacation, travel $2,000; dining, entertainment $200; sports, hobbies $200; miscellaneous (furniture, toys) $400; health insurance $50; cellphones $220; telecom, Internet $80; RRSP $3,000; professional associations $500. Total: $25,660.

Liabilities: Mortgage $800,000 at 2.6 per cent

Read more from Financial Facelift.

Want a free financial facelift? E-mail finfacelift@gmail.comSome details may be changed to protect the privacy of the persons profiled.

Note to readers: An earlier version of this Financial Facelift said the couple Eric and Ilsa spent $6,000 monthly on professional associations. In fact, that is the annual amount. Also, the article said Eric works one day a week in a clinic and one day a week teaching. The doctor has further clarified in saying he works up to 80 hours many weeks through longer working hours and extra days and hours both in medicine and teaching.