Two Mortgages Plus Job Loss Equals Cash Crunch

Andrew Allentuck, Financial Post

A professional couple we'll call Sally, 52, and Bruce, 57, have watched their well-formed plans get trashed by the recession.

Torontonians with a yen to be near the sea and the mountains of British Columbia, they bought a house in Vancouver for $830,000 at the market's peak. Not far from Stanley Park, their leafy street seemed a refuge from the concrete jungles of Toronto. Then the Ontario economy went into a tailspin and made it impossible for them to sell the Toronto house for the $700,000 they were asking for. One dependent child is in university, another is in primary school. Welcome to their cash crunch.

They figured they could carry the Toronto house by renting it out, as they did, for $33,600 a year. Add to that the $16,800 they take in from renting out a suite in their Vancouver house and they had annual property income of $50,400, which cushioned the $72,000 annual mortgage and property tax bills on the two properties. Bruce's job pays $92,000 a year and he collects a pension of $22,000 a year. Add in Sally's income, $120,000 a year, and they had positive cash flow and more than enough money to meet their $122,400 of annual expenses.

Then disaster struck. Sally's $120,000 civil service job went up in smoke. Their after-tax income fell below their out of pocket expenses, dominated by the costs of owning two homes.

"We thought that with our jobs and rents revenues, we had time to ride out the economic downturn. Unfortunately, I lost my job and prospects look dim to secure a comparable replacement," Sally says.

We asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Sally and Bruce.

DEBT REDUCTION

"Sally says without hesitation that she and Bruce prefer to sell the Toronto house," the planner explains. "Doing so would make it possible to eliminate their $230,000 Toronto mortgage and a $170,000 line of credit they used to buy the Toronto house. The balance of equity, $300,000, could be used to pay down their $640,000 Vancouver mortgage.

Sale of the Toronto house would also bring their spending into line with their income, Mr. Moran notes. They would give up $33,600 of annual rental revenue, but it would also put their budget back in the black.

Total monthly spending of $10,200 would drop to $7,700, which is less than their present $11,000 after-tax monthly income. That's the short-term fix that the couple needs, Mr. Moran concludes.

SALLY'S SEVERANCE

There are other issues. Sally received a $100,000 settlement when her job was eliminated. Should the money go into her RRSP, allowing her to defer substantial taxes? Should she use the money to reduce debt?

The best course, Mr. Moran says, is to request the employer pay only half the severance in 2009 and the other half next year. Sally has already earned $55,000 this year. She can put as much as $40,000, which is her unused room, into her RRSP. She can gift the balance of the money not used for the RRSP to Bruce, who would buy her a spousal RRSP.

There is no attribution in this case. He would put in $35,000, which would be enough to reduce his taxable income to the top of the second bracket, or $81,452 of taxable income, the planner suggests. Up to $5,000 of leftover cash could go into a Tax-Free Savings Account.

Contributions to a registered education savings plan for the child, now nine, can qualify for the Canada Education Savings Grant (CESG). The CESG is capped at the lesser of 20% of RESP contributions or $500.

Assuming that Bruce and Sally put in $2,500 a year and receive the full CESG supplement to their savings, and that the money in the RESP grows at a real rate of 3% per year, they could build up $27,477 by the time the child is ready for university. That capital would then pay $6,870 per year for a four-year degree. This cash flow would be sufficient to pay for tuition and books at a local university .

RETIREMENT

The couple's retirement plans have been devastated by the loss of Sally's job, but some reconstruction is possible.

Using a conservative assumption that she will not regain the job or an equivalent salary, the couple could have a retirement based on $22,000 per year from a pension that Bruce already receives, $16,800 a year from renting a suite in their Vancouver house, Canada Pension Plan benefits of $10,905 per person at age 65 and Old Age Security payments of $6,204 per person beginning at age 65. That amounts to $73,018 per year. Add Sally's defined-benefit pension from a previous job, of $26,000 per year, and the sum climbs to $99,018 per year.

The wild card in estimating retirement income is what happens to Sally. Assuming that $40,000 of her severance is rolled into her RRSP and that $35,000 of the severance goes into Bruce's RRSP, their present RRSP balance of $191,000 would grow to $266,000.

If that balance rises with no further contributions until Bruce is age 65 in 2107, and if assets earn a 3% real return, it would become $330,627 in 2009 dollars.

That sum, continuing to grow after the RRSP is converted to a Registered Retirement Income Fund (RRIF), would add $16,377 to the couple's annual income until Sally is age 90 in 2047, the planner estimates. This move would boost total retirement income after Sally turns 65 to $115,395 annually.

If Sally does get another job, she could add to her RRSP. If the job allowed her to contribute $1,000 per month, it would increase the eventual RRIF income stream by $5,444 per year, Mr. Moran estimates. That income boost would cover the loss of retirement income due to a cut in Bruce's employment pension when his CPP begins.

Their retirement will be secure if they can be sure of paying off their Vancouver mortgage that costs $3,500 per month.

Assuming that they sell their Toronto house and net $300,000, they can transfer the equity realized to their Vancouver mortgage. That would cut the Vancouver mortgage to $340,000. They could then make payments of $3,812 per month, and have the house paid off in eight years when Bruce is 65. If their mortgage interest, currently 1.85%, were to rise to 4%, the eight year amortization would require a payment of $4,139.

"Without new employment that provides even half of Sally's former income, the couple will have trouble being debt free by the time Bruce is 65 or taking full advantage of the CESG, Mr. Moran says.

"She really needs another job."

THE PROFILE
Monthly after-tax income $11,000

ASSETS
Toronto house $700,000
Vancouver house $830,000
RRSPs $191,000
TOTAL $1,721,000

LIABILITIES
Toronto mortgage $230,000
Toronto line of credit $160,000
Vancouver mortgage $640,000

TOTAL $1,030,000

MONTHLY EXPENSES
Mortgage, tax, water and insurance
Toronto house $2,500
Mortgage, tax, water and insurance
Vancouver house $3,500
Line of credit $500
Utilities and phones $370
Food $650
Restaurant $550
Clothing $100
Entertainment $100
Education expenses for child in university $500
Gas and repairs for car $500
Dry cleaning, grooming $200
Charity and gifts $330
Misc. $400

TOTAL $10,200