John and Olivia have made excellent progress over the past few years. They have a budget surplus of about $1,600 each month and are wondering how best to use the money.CHAD HIPOLITO/The Globe and Mail
In 2010, John and Olivia were in dire financial straits mainly because of the economy. They lost their house, John lost his business and they declared bankruptcy.
"We've slowly rebuilt over the past five years, with 2014 being a turning point for us," Olivia writes in an e-mail. "We both got jobs with much higher salaries," she adds.
Together, they bring in $144,000 a year before tax.
"Our debt is more under control, but we really don't know what our financial priorities should be."
They are in their mid 40s and have one child living with them; John has four grown children from a previous marriage. Olivia has a pension plan, but John has none.
They'd like to buy a home of their own, a condo, but real estate is expensive in British Columbia and their rent is relatively cheap. They fear it might rise substantially soon. If they can't afford a condo, they'd at least like to buy a modest cottage.
"Being able to escape once a month [to a cottage] makes our 50-hour work weeks bearable and our lack of true vacations tolerable," Olivia writes. "When might we be able to buy a $160,000 vacation property – a simple cabin on a piece of land on a Gulf island?"
We asked Calgary-based Morgan Ulmer of MeVest, a financial literacy and counselling firm, to look at Olivia and John's situation.
What the expert says
John and Olivia have made excellent progress over the past few years, Ms. Ulmer says. They have a budget surplus of about $1,600 each month and are wondering how best to use the money. They have student and personal loans totalling $83,600.
If they keep their payments as is, the loans will be paid off in slightly less than seven years at an interest cost of $11,177. If they add $1,350 of their monthly surplus to their loans and put the remaining $250 into an emergency fund, they'd have the debts repaid in two-and-a-half years at a much lower interest cost of $3,924. If their rent rises, they would have that much less money to put toward debt repayment.
Next, the planner looks at the prospect of Olivia and John buying a condo or a vacation property.
"Until the couple submits a mortgage application, it is difficult to know whether a traditional lender will approve them at standard rates," Ms. Ulmer says. Most lenders like to see at least two years of strong credit history as well as stable jobs and incomes, she says. Because of their previous bankruptcy, they might have to look at an alternative lender where rates would be higher.
Suppose Olivia and John bought a condo for $300,000 with 10 per cent down. The $276,500 mortgage, which includes Canada Mortgage and Housing Corp. insurance costs, would be amortized over 20 years, so they could pay it off before she retired. At a 4-per-cent rate, the mortgage would cost $1,670 a month. This would give them a total debt service ratio of 27 per cent, including their student loans ($886), personal loan ($280), mortgage ($1,670), heat ($175) and property taxes ($200), for a total of $3,210. Their gross income is $12,000 a month. Condo fees, hydro, home insurance and maintenance would add to their costs.
While buying a condo is doable, Olivia and John would need to keep their budget low.
"With significant student loans, low retirement savings and a child to put through school, they have multiple priorities for their money," Ms. Ulmer says. "A home is only one of them."
They would be better off waiting to buy until their loans have been repaid. This would allow them to save up a bigger down payment on a more expensive property. They might also be able to negotiate a better mortgage rate because they would have a longer credit and work history, she adds. By saving up a larger down payment, they would save on CMHC insurance costs, which run about 2 per cent or 3 per cent of the mortgage amount.
"This is thousands of dollars in savings," Ms. Ulmer says.
Buying a cottage is more of a luxury because they would still have to pay rent. If they bought one for $160,000 with 10 per cent down, they would have a mortgage of $147,856, including CMHC insurance. At 4 per cent amortized over 20 years, their mortgage payments would be $893 a month.
Add in rent and their debt-service ratio would be 31 per cent. "Olivia worries their rent will go up, so the number may get even higher," Ms. Ulmer says.
Add in other costs of owning and their monthly surplus would be wiped out, leaving them "absolutely nothing" for rent increases, extra loan payments, emergencies or retirement, the planner says. "It is, unfortunately, not a feasible option at this time."
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CLIENT SITUATION
The people: John, 47, Olivia, 45, and their daughter, 12
The problem: Can they afford to buy a condo or a cottage?
The plan: Pay off the loans first then save a 20 per cent down payment for a condo. Forget about the cottage for now
The payoff: A home of their own and a road map to financial security
Monthly net income: $8,200
Assets: Cash in bank $3,500; market value of her defined contribution pension plan from previous employer $15,744; value of her hybrid pension current employer $46,524; RESP $5,000. Total: $70,768.
Monthly disbursements: Rent $1,246; insurance $15; hydro $88; maintenance $30; transportation $418; groceries $700; child care $450; clothing $150; loan payments $1,166; gifts, charity $95; vacation, travel $100; other discretionary $50; eating out, drinks, entertainment $570; grooming $73; clubs $42; pet $50; sports, hobbies $200; subscriptions $23; dentists $75; drugstore $72; life insurance $21; disability insurance $128; telecom, TV, Internet $228; RESP $20; TFSA $200; pension-plan contributions $390. Total: $6,600. Surplus: $1,600.
Liabilities: Student loans $63,600 at 5.5-per-cent floating rate; interest-free personal loan $20,000. Total $83,600.
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