Natalie and Norm own a small house in British Columbia that they are quickly outgrowing. He is 43, she is 35. They have two pre-school-age children.
Both have good jobs with defined benefit pension plans. Together they bring in about $163,000 a year plus rental income of more than $1,000 a month from their basement apartment.
"Our plan is to save for a down payment on a larger home over the next four years and keep our current home as a rental," Natalie writes in an e-mail. They have recently stopped contributing to their registered retirement savings plans for the time being in order to save for the new home, which will cost about $650,000. They figure they can save about $166,000.
"So my question is, does it make sense to keep our current home as a rental when we buy that next home?" Natalie asks. Or would they be better off just selling the house and using the proceeds to help pay for the new one?
"This is within the greater context of planning for retirement (in about 17 years for Norm)," Natalie writes. Once they buy the larger house, they would focus on paying off the mortgage and saving for retirement. Are they on track? Should they balance their long-term savings between their RRSPs and TFSAs or is one better than the other?
We asked Ngoc Day, a fee-only financial planner at Macdonald Shymko & Co. Ltd., to look at Natalie and Norm's situation.
What the expert says
Ms. Day compares the couple's current cash flow to their projected cash flow after they buy a bigger house in September, 2019. She makes a number of assumptions: the car loan will be paid off by then, their childcare expenses will be offset by Natalie's salary increase; rent on the existing house will cover the operating expenses and that they put $166,000 down on a $650,000 house, leaving them with a mortgage of $484,000.
"I rounded up the mortgage to $500,000 to allow for some closing costs, moving expenses and new furnishings," Ms. Day says.
She based her calculations on a five-year, fixed-rate mortgage at 4 per cent, amortized over 13 years to match Norm's desired retirement date "to err on the side of prudence," the planner says. Their mortgage payment would be $4,100 a month.
"Based on the above assumptions, their plan to purchase a new home and keep the existing home for rental is feasible," Ms. Day says, "but – and this is a big but – they will just break even with no surplus cash flow on average and no wiggle room."
This could expose them to risks, the planner says. Interest rates can be expected to rise over time, increasing their carrying costs. There may be times they have no tenant, so they would have to pay the rental property costs with their already tight cash flow. As the children grow, their activities – such as sports and music lessons – will put added demands on their income.
The biggest risk is that one of them becomes disabled. Natalie's disability insurance would pay $4,000 a month but Norm's would pay only $1,750 a month. "If Norm was disabled, the family would have a significant reduction in monthly cash flow," Ms. Day says. This would cause severe financial stress.
"It would be more prudent for them to sell their current house," Ms. Day says. Having surplus liquidity means they would be better able to withstand the uncertainties that life throws at them."
Natalie and Norm have no emergency fund, the planner notes. She suggests they build up enough of a fund to cover three to six months' worth of expenses in their tax-free savings accounts.
Based on their income, Norm's marginal tax rate is 32.7 per cent and Natalie's is 29.7 per cent. "This means they could save between $30 and $33 of income tax for every $100 contributed to their RRSPs," Ms. Day says. She suggest they direct surplus cash flow to take full advantage of their RRSPs. She also suggests they contribute $2,500 a year for each child to a registered education savings plan to take full advantage of the federal government's Canada Education Savings Grant. Any surplus would go to their TFSAs for their emergency reserve fund.
The people: Norm, 43, Natalie, 35, and their two children.
The problem: Should they sell or rent their existing home when they buy a larger one in four years?
The plan: Sell the existing home and use the proceeds to help pay for the new one.
The payoff: Peace of mind and a sound financial footing.
Monthly net income: $10,465
Assets: Home $525,000; his RRSP $77,000; her RRSP $40,000; estimated present value of his DB pension plan $29,830; estimated present value of her DB pension plan $154,400. Total: $826,230
Monthly disbursements: Mortgage $2,130; property tax $160; water, sewer $85; home insurance $185; electricity $175; heat $35; maintenance, repair $500; car loan $375; car insurance $200; fuel $340; vehicle maintenance $205; parking $30; grocery store $860; child care $1,590; clothing $205; gifts, charitable $345; vacation, travel $420; other discretionary $420; dining, drinks, entertainment $420; grooming $70; doctors, dentists $125; vitamins, supplements $165; life insurance $65; telecom, TV, Internet $240; RRSPs $200; RESP $200; pension plan contributions $460. Total: $10,205
Liabilities: Mortgage $430,000; car loan $3,600. Total: $433,600
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