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This article was published 10/5/2013 (1110 days ago), so information in it may no longer be current.
Laurel is doing exceptionally well financially for her age.
She's 30 and owns a home, making do on a $50,000 annual income as a health-care professional. She even finds a little extra to set aside each month. All told, she has about $13,000 invested conservatively in a TFSA, RRSP and other savings.
But she wants to do better -- much better.
"I don't have a ton of debt, but I don't have a lot of money to do much other than pay the mortgage," she says. "If I could pay off my mortgage, I'd have a lot of extra money to save for the future."
To boost income, she has a roommate paying $700 a month, but Laurel has been mulling over a plan to supplement her income even more.
"I thought I would renovate my basement, which is out of the '70s, into a rental suite but I'd need to take out a loan."
Laurel estimates she'd borrow between $30,000 and $40,000 to spruce up the basement so she could charge a decent rent.
"But I started thinking, 'I'm making mortgage payments and then I'm making payments on this loan' -- is it even worth it?"
Sara Kushnir, a financial adviser with Assiniboine Credit Union in Winnipeg, says Laurel demonstrates excellent financial acumen, choosing to pay down her mortgage as quickly as possible. In this ultra-low interest-rate environment, more of every dollar she pays on the mortgage goes toward principal instead of interest.
Furthermore, rates won't be low forever, so it's best to pay as much as possible now because her interest costs are bound to increase in the future.
"Reducing the amount of interest she pays over the life of the mortgage means she will keep more money in her pocket," Kushnir says, adding Laurel could save tens of thousands of dollars in interest.
But Laurel only has so much free cash flow to increase her debt payments.
"Her expenses are eating up most of her income," Kushnir says. Still, she does have a monthly surplus of $282, even after biweekly contributions to her RRSP and TFSA.
The excess cash flow, however, is entirely dependent on rental income from her roommate.
"If this income was lost, the budget would be in the negative $418."
To protect against this potential loss, Laurel should start an emergency savings fund that could make up the $400 deficit for about five months.
But if Laurel decides to renovate the basement, her margin for error will be even smaller, Kushnir says.
On a 10-year home-equity loan for $40,000 at 3.5 per cent interest, Laurel would have a monthly payment of $395. On five-year paydown plan, the monthly payment is about $722.
"Renting the suite for $900 or $1,000 a month does not leave much room for a rise in utilities and incidentals -- not to mention leaving extra money for additional mortgage payments," Kushnir says.
But if Laurel can stick to a five-year amortization on the rental-suite loan, she will free up $850 a month after five years. Using that money for additional mortgage payments, she will be mortgage-free in 13 years instead of the current 23-year amortization.
While the plan is workable, she is again at risk of losing a renter and finding herself with an even larger deficit to make up in a pinch.
Kushnir says Laurel might want to consider a less risky alternative, but it involves a lot of short-term pain for long-term gain.
"If Laurel could take her current $280 monthly surplus and cut $220 more from her monthly expenses, she would have $500 a month to apply to her mortgage principle," Kushnir says. "This would reduce her amortization to about 12 years."
Her budget is already fairly tight, so this may not be workable. Still, it may be worth her time to track expenses for a couple of months to see if she can find a few dollars here and there to come up with the savings.
Even if she can find those savings, Laurel might want to look at a different strategy that focuses less on debt repayment and more on saving for the long term.
"If she took the $500 monthly away from the mortgage and contributed to a tax-sheltered account such as an RRSP or TFSA, she would have over $700,000 at age 65 based on an annual return of six per cent," Kushnir says, adding this would require Laurel to invest in higher-risk savings vehicles than GICs. "Adjusted for two per cent inflation, that's about $375,000 in today's dollars."
In contrast, in choosing the accelerated mortgage payment route -- whether that's with the rental-suite plan or finding budget savings -- she will be mortgage-free at about 43.
Afterward, if she can then set aside $1,500 a month, with a six per cent annual rate of return, she'd have about $900,000 by age 65. That's about $600,000 in today's dollars.
Combined with her work pension, either strategy should be enough to meet her retirement needs, Kushnir says.
One note of caution: A serious accident or illness would put any plan she chooses at risk, so she should consider purchasing critical-illness and disability insurance now while she's young and premiums are low. Although she may have coverage with her employer, it may not be sufficient.
No matter the strategy, Laurel is likely to be successful because she already has proven herself a good financial manager. She budgets, she saves and she is ambitious.
Now she just has to weigh the returns versus the risks and do her best to protect herself against worst-case scenarios.