Sheryl Nadler for The Globe and Mail
Sandy and David were doing fine until a year ago. They had a comfortable lifestyle and their income was slightly higher than their expenses. But they have a mortgage, a home equity line of credit and a personal line of credit. Total debt: $205,840.
Then Sandy's company downsized and she was laid off – not a good position to be in at 62 going on 63. Late last year, David's consulting job wound down. He is 67.
"Double whammy!" David writes in an e-mail. To get by, they dipped into Sandy's severance package. They got a big tax refund, which they soon spent. Then they cashed in a small registered retirement savings plan.
"Looking forward, if nothing changes, we will have to start drawing funds from our bank account or my wife's RRSP mutual fund, find ways to reduce our expenses or look at other ideas like selling our home," David writes. They have a townhouse in Oakville, Ont.
They are not without income. David gets Canada Pension Plan and Old Age Security payments, a small company pension and earnings from a "fairly secure" part-time job. Sandy gets CPP, monthly withdrawals from a life income fund, a small employment insurance benefit and occasional income from a series of temporary part-time jobs. Altogether, it adds up to $4,600 net a month – about what they spend each month, leaving them vulnerable to a rise in interest rates.
They figure they'll need at least $50,000 a year before tax to live on when they ultimately retire. We asked Stephanie Holmes-Winton, author of Defusing the Debt Bomb, to look at Sandy and David's situation.
What the expert says
While the situation is serious, it is not uncommon, Ms. Holmes-Winton says. "Like many people, they felt everything was okay until all of a sudden it wasn't." The main problem is that David and Sandy don't seem to have a good handle on their spending, she adds.
"From experience I know that if they don't change their spending habits, it is more than likely the lines of credit and even the credit cards could still be carrying balances in five years," Ms. Holmes-Winton says.
One alternative the couple is considering is selling their townhouse in 2015 when the mortgage comes up for renewal and renting their son's condo apartment nearby for $1,000 a month. If they sell earlier, they face a mortgage prepayment penalty of more than $3,200.
As Ms. Holmes-Winton sees it, they should not be too concerned about the $3,200 penalty because it pales in comparison to how much interest they can save if they can successfully reorganize their debt. She recommends a two-part solution: cut lifestyle spending in half and roll their mortgage and lines of credit into an all-in-one mortgage loan such as Manulife One. Having just one loan will help them focus on paying it down.
Her calculations assume a floating rate on the new loan of 3.5 per cent – lower than they are paying on their current debt. Given the interest savings and the faster repayment, their outstanding debt could be more than $50,000 lower by 2015 when they sell their house, she estimates.
Indeed, of the $65,980 they will pay on all of their debts between now and 2015 if they leave things as is, a whopping $43,520 will be interest. "Essentially, 66 per cent of every dollar is interest, which is just not worth it to avoid a $3,200 penalty."
Currently, Sandy and David are spending somewhere between $1,875 and $2,165 a month on variable lifestyle expenses – nearly half their income. Ms. Holmes-Winton suggests they allocate $240 a week in cash from their income for groceries, dining out, coffee, clothing, entertainment, gifts, donations and anything else they want. She also suggests they cut their vacation spending to $2,000 a year, which they can save up by tucking $166 a month into a savings account. This will cut their variable spending to about $1,200 a month or 26 per cent of their net income.
"This change will have to be lifelong."
They could then redirect the $900 a month in savings to their Manulife One account, lowering their total interest expense over five years to $28,600. Over the next four years until they sell their home, Sandy and David can withdraw $12,000 a year before tax from Sandy's savings to complement their other income. Ms. Holmes-Winton's calculations assume they sell their townhouse in 2015 for $340,000 and invest the proceeds, net of mortgage and fees, for a 4.5-per-cent average annual return.
The money could be invested 90 per cent in fixed income products such as annuities and 10 per cent in equity-type securities.
If all goes well, the couple will be able to retire comfortably once the house is sold and the debt repaid. If for some reason they are not able to renegotiate their debt, they should allocate the extra $900 a month of cash flow gained from the spending cuts first to the personal line of credit, then to the home equity line of credit and finally to the mortgage until the house is eventually sold.
CLIENT SITUATION
The People
Sandy, 62, and David, 67
The Problem
How to cope with a cash crunch, substantial debt and lower income and still have enough money to live on.
The Plan
Cut spending and renegotiate debt to roll it all into one lower-rate mortgage loan. Then redirect the extra cash flow from the spending cuts to pay off the debt until the house is sold a few years hence and the proceeds invested.
The Payoff
Savings that will last a lifetime as long as spending is kept firmly in check.
Monthly net income:
$4,600.
Assets
Sandy's life income fund (LIF) $65,000; Sandy's RRSP $60,000; home $325,000.
Total: $450,000
Monthly disbursements
Mortgage $1,495; utilities $265; telecom, cable $170; home insurance $30; car insurance $135; car lease $240; health insurance $45; personal line of credit $100; home equity line of credit $125; groceries, drinks, dining out $900; clothes, grooming $200, vacation/entertainment $600; gifts $100; donations $25. Total: $4,430
Liabilities:
Mortgage $163,840 at 4.62 per cent; personal line of credit $12,000 at 5 per cent; home equity line of credit $30,000 at 4 per cent. Total: $205,840
Special to The Globe and Mail
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