Cash-strapped Couple Ponder Best Route to A Condo


Two men in Ontario we'll call Bill and Tom, both 27, plan to marry this fall.

Professionals, they have good careers and have a combined annual gross income of $111,000. They figure that they should be able to afford a condo in the $300,000 range.

They ought to be able to afford the condo, but they have relatively little financial capital. Most of their combined savings of $28,000 are in registered retirement savings plans. Their cash on hand is just $4,300. They could apply some of this money to a Home Buyer's Plan loan from their RRSPs for a down payment, but that would still leave them short of the 20 per cent that one needs to have for a conventional mortgage.

"We don't want to have to change our lifestyles in order to purchase a home," Bill explains. But their financial situation suggests that they will have to make some changes to their savings if they are to come up with the down payment.

What our expert says:

Facelift asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Bill and Tom in order to sort out their options and to find ways to finance their plans.

"The quickest route to home ownership is by taking full advantage of the RRSP Home Buyer's Plan. Each can use as much as $20,000 of an RRSP as a down payment, which must be repaid over a 15-year period. The money will not be working as an investment, but the cost of lost potential gains is still reasonable."

A $40,000 down payment actually has an after-tax cost of $27,540. The difference is the tax savings they have already received through RRSP contributions, Mr. Moran explains. The down payment will be less than the conventional 25 per cent down payment, which would be $75,000 on a $300,000 home. However, with their steady jobs, they can meet the criteria for a high-ratio mortgage insured by Canada Mortgage and Housing Corp.

CMHC fees for mortgage insurance will be 2 per cent of the sum lent. That should be $5,200. Were they to increase their down payment to $45,000, the fee would drop to $4,550. At $60,000 down, the fee would be 1 per cent or $2,400. In each case, the fee is added to the amount borrowed.

Bill already has $18,000 in his RRSP, so the couple need to focus on building up Tom's RRSP, which currently has a balance of $2,000. For the best results from a tax point of view, Tom should put $7,000 into his RRSP before the March 1, 2009 deadline. Then Bill should invest the balance required, an estimated $11,000, in a spousal RRSP for Tom. Bill will get the tax deduction and Tom will get the RRSP investment.

This year, therefore, Bill should add $2,000 to his RRSP and then add sufficient funds to bring Tom's RRSP up to $20,000.
There are some important rules to follow in order to make the RRSP contributions work for the Home Buyer's Plan. First, the RRSP contributions have to be made at least 90 days before being withdrawn for the HBP. Repayments must begin not later than 60 days after the end of the second year following the first withdrawal. Annual minimum payments would be $2,667, assuming that each makes the full $20,000 contribution to his RRSP. The sums in the RRSPs should be in money market funds or high-interest savings accounts or a short-term guaranteed investment certificate, to minimize risk.

If Bill and Tom get a $260,000 mortgage at 5 per cent with a 25-year amortization, they would have to make monthly payments of $1,512. Their present rent is $1,100 a month. They have substantial savings capacity, so they should be able to handle the higher monthly cost. If they can add $100 a month to their mortgage payments, it will cut the amortization by 34 months and save them $25,148 of interest, assuming that rates stay at 5 per cent.

Retirement planning should be relatively easy, because Bill and Tom say they do not include children in their future. If Tom saves $190 a month and is matched by his employer for a total of $380, and Bill saves $1,170 with employer matches included, then with 6-per-cent growth and 3-per-cent inflation assumed in the calculation, they will have $844,274 in 2008 dollars at age 55. At age 60, they would have $1,077,500 in their RRSPs. At 65, they would have $1,347,860, the planner estimates.
Each will qualify for Canada Pension Plan credits. At age 65, they should each receive close to $10,615, the maximum payable in 2008. At that time, they will also qualify for Old Age Security, currently $6,028 a year. Both CPP and OAS are indexed and taxable.

Adding up their various public pensions and their as-yet undetermined employment pensions, they should have total retirement income at 60 of $90,000 to $110,000. If they work to age 65, their retirement income would rise to $100,000 to $120,000 a year, the planner estimates.

"Bill and Tom are starting out with modest savings, but they have opportunities as professionals in their fields to build substantial wealth," Mr. Moran says. "They are off to a good start, and frankly, in seeking a Financial Facelift at their relatively young ages, they have done the smart thing - planning early for later rewards."

Client situation

The People

Bill and Tom, each 27, plan to marry this fall.

The Problem

Buying a house with low savings.

The Plan

Invest in RRSPs to build up capital for the Home Buyer's Plan.

The Payoff

Sufficient money for an insured mortgage.

Net Monthly Income

RRSPs $28,000, cash $4,300, stocks $2,000. Total: $34,300.

Monthly Expenses

Rent $1,100, phones $150, food & restaurants $1,000, entertainment $500, clothing $250, RRSP $1,350, car & gas & repairs $100, travel $350, student loan payment $150, charity & gifts $25, miscellaneous $600, savings $1,558. Total: $7,133.

Student loan $1,500.

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