A Longer Mortgage Provides a Timely Solution

In Toronto, a couple we'll call Chuck, 47, and Ellen, 44, have two kids ages 11 and 14. They have good jobs, he in a media company, she in public service, and $2-million in personal and financial assets, including a house they figure is worth $1.3-million. Their liabilities total $284,000.
Many people would envy the financial security they have achieved, but they worry that expenses and allocations, which exceed their monthly take-home income of $13,000, will cripple them.

"We are living beyond our means," Chuck says. "I don't see our incomes increasing nor expenses decreasing unless we make changes in our way of life."

What our expert says

Facelift asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with the couple to sort out priorities and to develop a financial plan for managing costs and their balance sheet.

"They have problems: No cash in the bank, underfunded education plans for their children, and a lot of interest flowing to lenders," he says.
Chuck and Ellen's spending, such as $2,018 a month for child and house care and kids' sports, could be trimmed. Yet some of the cash flow they allocate to various budget items is actually savings; for example, the $500 they put into registered retirement savings plans and the $330 they put into a family registered education savings plan every month. Their largest budget item, $3,000 for their house mortgage, is partly a transfer of money from cash to real estate and, of course, partly interest paid to the lender. They use a line of credit to make part of their mortgage payments. They need to cut current expenses.

They could begin cutbacks by selling a vacation condo they own without any debt. Property taxes and condo fees are $300 a month. The condo ties up $250,000 of their capital. If the money tied up in the condo was in a 3-per-cent guaranteed investment certificate, it could earn $7,500 a year. Add in the $3,600 they spend on taxes and maintenance on it each year, and it is costing them $11,100 a year. They use the condo no more than a dozen weekends a year. A sale would make sense, yet family ties make that difficult.

As an alternative, they can extend the mortgage on their city house so that the debt will be paid off in 10 years rather than the five years they have planned. Their monthly payments would drop to $1,300 and they would then have $1,700 each month to build an emergency fund of a few months' income and to raise their contributions to their family's RESP to $417 a month or $5,004 a year.

The boost in RESP savings would maximize the amount they get from the Canada Education Savings Grant, which is $500 on the first $2,500 of contributions per child a year. The enhanced RESP contributions would result in their combined RESP and funds in trust for the kids, a total of $65,000, to grow to $49,500 for the child now 14 and $63,650 for the child now 11, assuming a 3-per-cent real rate of return. The elder child would have $12,500 a year for four years, the younger $16,000. The parents could, of course, just average out the amounts to $14,250 a child per year. All sums are in 2009 dollars.

Chuck and Ellen can each expect full Old Age Security benefits, now $6,204 a year. Ellen can retire at age 54 with a full pension of $59,150 a year with a bridge of $5,850 a year to age 65 when her Canada Pension Plan benefits of $9,554 a year will begin. If she works to age 57, when Chuck is 60, her pension, a defined benefit plan indexed to the cost of living, would grow to $65,600 a year plus a bridge of $6,489 to age 65, Mr. Moran says.
Her registered retirement savings plan is minimal and can be disregarded in the retirement analysis, he adds. With no other pension income, she would have $71,804 a year at age 65, assuming retirement at age 57. She will be affected by the clawback, which currently begins to take back OAS benefits when net income exceeds about $65,000 a year.

Chuck can expect CPP benefits at age 65 of $9,108 a year. He is adding $500 a month to his RRSP. It has a current balance of $335,000. By his age 60, it will have a balance of $588,500, assuming a 3-per-cent real rate of return. If he were to spend this sum evenly over the 33 years to his assumed death at age 90, he could withdraw $27,513 a year, the planner estimates.
The couple would have a pretax cash flow of $124,183 at age 65, which is more than their $120,000 target gross retirement income. They will also have the income or capital gains from the potential sale of unregistered shares in Chuck's company and, perhaps, the income they might derive from money obtained through the sale of their vacation condo or even from downsizing their house and moving to something less expensive.

"This couple can fix their cash flow problems either by cutting back on expenses or by extending the mortgage amortization for their house," Mr. Moran says.

"I am not surprised that Mr. Moran has suggested we extend our mortgage," Chuck says. "That is probably what we will do."


Client situation

The People

Toronto couple in mid-40s with children ages 14 and 11.

 The Problem

Overspending, no cash in the bank, financial anxiety.

The Plan

Extend mortgage and cut payments, beef up RESPs.

The Payoff

More money for kids' education, money for emergency fund, less anxiety.

Net Monthly Income

$13,000.

Assets

House $1,300,000, condo $250,000, RRSP $335,000, RESPs $50,000, kids' trusts $15,000, unregistered stock $25,000, cars (2) $25,000. Total: $2-million.

Monthly Disbursements

Mortgage $3,000, prop. tax house $600, utilities & phones $560, food $1,100, restaurant $200, entertainment $350, kids' sports & camps $768, clothing $500, child & house care $1,250, RRSP $500, RESP $330, cars fuel & repairs $700, travel $660, vacation condo costs $300, car & home insurance $325, life insurance $85, line of credit $1,700, Misc. $250, charity & gifts $492. Total: $13,670.

Liabilities

Mortgage $205,000, line of credit $40,000, invest. loan $9,000, car loans $30,000. Total: $284,000.

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