Feathering THE LOVE NEST

Hey there, time traveller!
This article was published 30/10/2010 (5474 days ago), so information in it may no longer be current.

Lou and Pearl, both provincial bureaucrats, are a couple of lovebirds looking to build their futures together on top of the strong financial foundations they’ve each already laid down on their own.

In their mid-40s, each one owns a home with a mortgage, has retirement savings and earns a good income.

Having decided to move in together, they now plan to embark on an ambitious renovation of Pearl’s home — a.k.a. the love nest.

The estimated cost of building upward and outward will be about $240,000. The home’s present value is $275,000, on which Pearl owes about $62,000.

While that home is renovated, they would live at Lou’s abode, valued at $180,000, on which he owes $121,000.

But the couple is apprehensive they are taking on too much debt at this stage in the game.

“We definitely don’t want to be house-poor and have our quality of life affected,” says Pearl, who earns $77,000 a year.

Renovation costs included, they want to have the mortgage paid off in 15 years — when they plan to retire. And while they understand selling both homes and then buying a new home would be less costly, they prefer the renovation route, keeping both homes — living in Pearl’s and renting out Lou’s.

“We want to stay in this neighbourhood and we can’t really afford to buy another house here and tear it down,” says Lou, who earns about $55,000 a year.

So, what they’d really like to know is, does their plan to shack up stack up?

As it just so happens, certified financial planner MaryAnn Kokan-Nyhof has recently done a buildup and build-out renovation on her home.

But before the adviser with MGI Financial in Winnipeg tackles the financial nuts and bolts of taking on a major renovation, she says she would ask them to reflect upon some often overlooked but important considerations when merging personal assets.

“When I have people in my office and they’re telling me they plan on moving in together, I put the pen down and say ‘OK, I need to bring this up now, because once you move in together, basically marital property rights take over very soon afterward and everything you have can be split down the middle,” she says about how common-law relationships are seen in the eyes of the law.

A prenuptial agreement might be a consideration and at the very least, they should update their wills.

“Who are the beneficiaries right now? Are those the people who they want to have all their earthly goods when they die, or now that they’re in a relationship, do they want to share all their assets?”

Once those aspects of their proposed merger are dealt with, they’re ready to tackle the biggest financial challenge: the renovation.

And it’s going to be a doozy, she says.

“I’ll be honest with you. It’s a hassle. I wouldn’t do it again,” Kokan-Nyhof says about her experience.

“Every time you open a wall on an old house, you don’t know what you’re going to find behind it.”

That said, their $240,000 estimate seems reasonable and at least they have Lou’s place to reside in during the construction.

Kokan-Nyhof says they will need a builder’s loan to finance the renovation.

“It will give them up to 75 per cent of the value of the renovation without any additional mortgage insurance,” she says, adding they would likely get up to a $180,000 loan without CMHC insurance.

And Pearl has a $150,000 line of credit that may be able to absorb the remaining expenses if they don’t want to use CMHC. But the line of credit will be needed regardless, because it will help provide bridge financing.

Builder’s loans are often provided in phases. The money is forwarded for each phase only after it has been completed.

“The challenge with that is they will have to use some of that personal line of credit to complete each stage before the bank will give them the money,” she says.

“Basically, they are going to have to build the stage and then get the money.”

Once the entire project is finished, the loan — likely with a floating, prime-plus interest rate — will be rolled into the existing mortgage on the home.

But the fun doesn’t stop there.

Kokan-Nyhof says it’s unlikely they will be able to pay off their newly renovated home’s mortgage in 15 years.

“A current $240,000 mortgage for 15 years would have a monthly payment of $1,891 a month or $22,692 a year in total payments,” she says.

Kokan-Nyhof did a rough total debt service ratio calculation measuring their ability to carry their liabilities. Financial institutions use this as a yardstick when determining whether to provide financing. The rule of thumb is combined debts, taxes and utilities must not exceed 40 per cent of gross income.

Lou and Pearl have the ability to carry about $12,000 a year more in debt costs, which means an accelerated mortgage paydown might be a bit of a financial stretch.

If they plan to rent Lou’s home, they will have more flexibility, and they may be able to pay off all their debts at a faster rate, she says.

Yet, even with the rental income paying off one mortgage, their debt costs will be increased, which may force them to make some lifestyle changes.

Kokan-Nyhof says they spend more than $2,300 a month combined on groceries, shopping, entertainment and dining out. And that’s not counting a few hundred dollars left over each month, which she says most likely are used for discretionary spending.

“They should understand that the implication of having this big, beautiful renovated house is that it’s likely they may not be able to do much else.”

Still, if they love the neighbourhood and they’re willing to make the financial sacrifices, knowing full well the potential pitfalls, they’re likely making the right decision.

But Kokan-Nyhof says they should take their time and seek out additional advice beforehand because it’s a tough decision to undo.

“Once they start, they can’t go back because for the first five years after the reno, if they try to put the house on the market, they likely won’t get back the money they put into the home if they sell it.”

giganticsmile@gmail.com

Lou and Pearl’s finances

�ñº INCOME

Lou: $54,540 gross annual, $3,078 net monthly

Pearl: $77,700 gross annual, $3,956 net monthly

�ñº EXPENSES

Lou: $2,695 a month, including his mortgage

Pearl: $3,510 a month, including her mortgage

�ñº LOU’S DEBTS

Mortgage: $121,818 owing with biweekly payments of $316.91 at 4.78 per cent interest rate; home assessed at $180,000

Line of credit: $5,952 balance at 4.78 per cent interest rate

Credit card: $5,330 owing at 14.9 per cent

�ñº PEARL’S DEBTS

Mortgage: $61,990 owing with biweekly payments of $349.44 at floating rate, prime plus one per cent; home assessed at $275,000

Line of credit: $11,800 at prime plus one per cent.

Hydro loan: $1,986 owing with monthly payment of $57

�ñº LOU’S ASSETS

RRSPs: $14,610

LIRA: $21,840

Expected monthly pension payment at age 62: $1,984

�ñº PEARL’S ASSETS

TFSA: $3,125

RRSPs: $58,638

Expected monthly pension payment at age 55: $2,793