Personal Finance

Winnipeg Free Press - PRINT EDITION

Home truths hit hard

Kim's dream of a little house on the prairie a financial minefield

By: Joel Schlesinger

Posted: 02/18/2012 1:00 AM | Comments: 0 (including replies)

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An advisor says Kim can take steps to make home ownership more affordable. (PHIL HOSSACK / WINNIPEG FREE PRESS)

Kim's finances

INCOME

Anuual: $34,452 ($2,496 monthly net)

EXPENSES

Monthly: $1,968

DEBTS

None

ASSETS

RRSP: $30,000

Savings: $148,000

Work pension: $90,000

Farmland: $60,000

Total assets: $328,000

Kim would like a home to call her own.

In her mid-50s and divorced, she is an apartment-dweller who longs for a nice little bungalow -- preferably on the prairie.

"I'd dearly like to live on the outskirts of the city, but I'd also need to own a car again, and I'd like to figure out whether that's at all feasible," she says, adding she'd buy a used car for less than $15,000.

Kim has spent most of her working years at home raising three children, now all adults, and she receives $2,500 a month in spousal support.

She also earns $221 a month in rent from several acres of farmland she owns, and she receives $150 in interest a month from about $148,000 she has sitting in savings.

Kim has about $30,000 in an RRSP invested in a money-market account and a $90,000 pension from a settlement with her ex-husband.

"I'm a very conservative investor," she says.

Her monthly expenses are $1,968, and she has no debt.

But Kim worries about whether she can afford a home, especially when her ex retires and spousal support drops. She says she plans to find part-time work to make up the shortfall and if she bought a home, she might rent a room to help cover costs.

"Am I better off renting, and if buying a house doesn't work, where should I invest my money?" she asks. "Is there a way I can buy a house and still invest money? I'd like to figure out what my options are."

Kathy Holod, a financial adviser with Scotiabank in Winnipeg, says Kim has enough liquid assets to afford a down payment on a home and buy a car outright.

But the question she needs to answer is what effect will the cost of home ownership have on her cash flow?

Even though she has a monthly surplus of more than $500, which she generally puts into savings, Kim's expenses will rise significantly if she owns instead of rents.

"There are also the costs of land-transfer tax and legal fees when purchasing a home."

Holod says Kim could likely find a bungalow around the $200,000 mark within 30 minutes' drive of the city. Closing costs would be about $4,000.

Not including a mortgage payment, she would have new costs to factor into her current budget: utilities, property tax, home insurance and home maintenance. All told, these would cost an estimated $677 a month.

She must to factor in car-ownership costs. She won't have a loan payment, but insurance, gasoline and maintenance would cost about $425 a month.

All told, she could be looking at $1,102 more in expenses every month.

"She would have savings to offset some of these costs, because she would no longer be paying rent and buying a bus pass and tenant insurance," Holod says. This would reduce her existing monthly expenses by $949.

These expenses would increase her monthly costs to about $2,052. That's without a mortgage payment.

Kim would still have a monthly surplus of about $400, but she will need to budget for a mortgage payment, too, because she does not have enough liquid assets to buy a home outright.

Before figuring out how much she can afford for a down payment, Kim should set aside at least $20,000 in a tax-free savings account for the future, and she also needs an emergency fund.

"Using the traditional recommendation of three months' income, she should have at least $8,613 in that fund," Holod says. "Since she is considering purchasing a home and may have more unexpected expenses, I would recommend she set aside $10,000 of her non-registered funds for emergency purposes."

That would leave Kim with about $118,000 in savings, excluding her RRSP and pension. Subtracting closing costs and the vehicle purchase, she would have about $99,000 for a down payment, leaving her with a $101,000 mortgage. At a four per cent fixed interest rate, her monthly payment would be about $531 amortized over 25 years.

This would boost her monthly costs to $2,580, more than her current monthly income.

Yet Kim will have even less money than she earns today because she will have liquidated most of her assets.

"Kim would no longer receive interest income, reducing her monthly income to $2,346," Holod says. "That's a shortfall of approximately $234."

Although that's bad news, Holod says Kim can make home ownership more affordable.

If she finds a part-time job for 20 hours a week, even earning minimum wage, she could make up the shortfall. She could also trim expenses.

"If that isn't an option, then she'd have to look at renting a room."

But she also must plan for when her ex retires and spousal support drops.

One thing she has in her favour is she will receive government benefits in her 60s, but it's likely the bulk of that money won't be accessible until she turns 65, Holod says. "Depending on how long, if at all, Kim has been in the workforce, she may or may not qualify for CPP."

Once she turns 65, she can collect OAS. But in the meantime, she may need to draw on her $90,000 pension and RRSP to cover costs if other sources of income aren't enough.

Dipping into these sources of funding early will have a long-term impact on her finances, so Kim has much to consider before proceeding.

The barriers to home ownership aren't overwhelming, but she might not be comfortable taking on this much risk, Holod says. Still, even continuing with the status quo is risky. Holod says even Kim's current, ultra-conservative investment strategy is prone to inflation risk.

For example, if she earns one per cent on savings and inflation is three per cent, she is losing two per cent a year.

Regardless of whether Kim buys a home, she should at least invest her TFSA savings in a conservative, balanced portfolio that grows her money ahead of inflation without the drag of taxation.

She should also be mindful that if she does run into money trouble as a homeowner, she could sell her farmland. But that, too, would reduce her monthly cash flow because she no longer would earn rent from the land, and she should consult an accountant on the tax implications.

Holod says the simple answer is Kim can afford a home. But she needs to consider if she values home ownership more than living easily within her means, as she does now.

"Is her desire to live outside the city enough for her to make these important changes to her financial plan?"

giganticsmile@gmail.com

Republished from the Winnipeg Free Press print edition February 18, 2012 0

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