Case Study: Paul and Melanie Want to Buy a House
Paul emailed me for some guidance on his financial situation. Paul and his girlfriend, Melanie, has good combined income, some debt, and a dream of owning a home in the very near future. Paul emailed me all of his financial stats to be shared with MDJ readers.
We both live in Ontario. Melanie lives in Mississauga and I live in Markham. Due to life circumstances and other factors, we are both currently living at home with our respective parents. We are 33 and 28 years old.
For our future house, we are looking at $290,000 to $300,000 price range and, realistically are looking to put down the minimum 5% down. We are flexible in the location but would prefer to live near my work (Richmond Hill) so there is a minimal commute.
For other financial goals I would have to say it would be like other average Canadians: a) pay down mortgage (asap), b) save for our future retirement, c) save for children’s education.
EXPENSE Monthly Yearly Rogers 200 2400 RBC Loan 515 6180 CAR Insurance 145 1740 Future Shop 50 413 Ends August 2009 GAS (RBC Visa) 350 4200 SPEND 1000 13000 Misc. 55 660 Total 2315 28593
EXPENSE Monthly Yearly CAR Insurance 100 1200 TD VISA 85 1020 FIDO 100 1200 Rogers 40 480 Future Shop 60 498 Ends August 2009 BMO Mosaik 300 3600 School 115 1380 Gas 150 1800 Spend 450 5400 ` Total 1400 16578
Type Amount Interest TD VISA 3600 11.25 Future Shop 911 0 BMO Mosaik 11200 11.9 RBC Loan 22631 8.8 School Loan 3629 6.5 Total 41971
Mortgage Total 242550 3.40% Monthly Mortgage Payments 1100 Prime – 0.60% Monthly Rent 1850 5 Year Variable 40 Year Amortization 1st Mortgage Payment: June 2008
Monthly Net Monthly Gross Yearly Gross Paul $3,700 $5,700 $74,100 Mel $1,800 $2,200 $28,600 Total $5,500 $7,900 $102,700
CHQ ACCT 1000 SAV ACCT 1000 ING Savings 5900 Investments 1564 ING RSPs 1585 Total 11049
ING RSPs 450 Total 450
Bi-weekly Yearly Paul 692.5 18005 Mel 200 5200 Will begin Jan/09 Total 892.5 23205
To add to the numbers above, a $300k house with a 5% down payment and 5.25% interest rate, would cost around $2080/month including property tax (~$300/mo), insurance (~$45/mo). However, this does not include utilities which can vary by province/state.
Here are some of my initial thoughts that stand out. With a combined after tax income of $5,500 and expenses that total $3,715 that leaves $1,785 every month in positive cash flow. If Paul were to “spend” a little less during the month, they could easily have $2,000/month in cash flow.
Even with the decent cash flow, they currently don’t pay any rent as they live with their parents. This means that the $2k cash flow would have to support their house payments which is clearly not enough. However there is hope as they have high debt servicing costs that can be paid off. In addition, they plan on staying put for another year or so.
Get Rid of that Debt!
What really stands out in the report above is the amount of debt that they hold, bad debt at that. If it were me, I would take all of the savings that are not RRSP’s, and pay down debt starting with the highest interest credit card debt. If they were to wipe out their savings but keep their chequing account and RRSP balance in tact, they would have around $8,500 to work with.
Putting the entire $2,000/month of cash flow (in addition to the $8,500) towards debt, it would only take them around 17 months or around 1.5 years to pay it all off. The more they save, the faster the debt gets paid off.
After paying off the debt, it then would be a great time to start saving for a down payment on the dream home. As it stands right now, 5% on a $300k house would be around $15k down + closing costs. In fact, it may be a good idea to take advantage of the RRSP Home Buyers Plan and max out Paul’s unused contribution room. They can then withdraw the proceeds from the RRSP as the down payment when the time is right.
How long will it take to save for the $15k down payment? Not as long as you think! Since they will have their debt taken care of, it means that the extra cash flow can be saved; approximately $1,300/month. In total, they will have around $3,300/month cash flow, which will cover their down payment in about 5 months (not including potential income tax returns).
What does their cash flow look like with a new home? With a monthly payment of around $2,080 plus utilities, it seems that their cash flow of $3,300 should be more than enough to cover it. Although personally, I wouldn’t be comfortable with a mortgage that is greater than 2 times salary. Then again, I am fairly conservative when taking on new debt.
In summary, I believe that it will take about 2 years for Paul and Melanie to dig themselves out of the hole and into their dream home. However, that’s only if they are willing to buckle down and get aggressive with paying down debt.
Do you have any suggestions for Paul and Melanie?
Disclaimer: The articles posted on Million Dollar Journey are the opinion of the author and should not be considered professional financial advice. Please consult a financial professional before making any major financial decisions.