The personal finance questions via email keep rolling in. Recently, Heather inquired about her financial situation and how would she go about reaching her goals. She is recently divorced and raising a child. While married, she worked in the family business, but now her only income is spousal and child support payments. She has a significant real estate asset – her principal residence in Vancouver.
Hi, I own a home in Vancouver. It’s half paid for. It’s my future retirement fund, I’m 42, currently divorced on spousal support for five more years. I’m concerned the housing market is going to take a financial downfall soon, should I get out and buy a town home, have no mortgage and then do what with the balance of the remaining money? Can you confidentially give me your gut instinct on whether real estate is worth holding? If I sell, I would buy a home in a different area, but the quality would not be the same, the lot half the size, the neighborhood is ok, but not upper class. I’m guaranteed 7,000 per month for the next 5 years, ( spousal) , my home is worth $1,000,000, remaining mortgage is 435,000 @ 3.48% fixed 5 year term.
Given a stable financial situation for the next five years, would you sell and downsize and have no mortgage, invest the rest in the stock market, or conversely, ride it out with the real estate for five years but then have to sell once that time is up?
I’m not working yet, studying part time at UBC, raising a child. I expect to work full time (@$50k/yr) within five years but cannot count on a predictable income amount then, it is an unknown.
Car is paid off.
I’m not currently contributing to my RRSP’S in favor of the TFSA.
I can get a nice new home for $670,000 and be mortgage free. Town homes are around $300k – $400k.
The goal is financial independence by 50. I think I’ll need at least 40,000 a year to retire.
The new home I looked at I. A different location us 670,000. Big, new, nice. Half the size of the lot but may have an upside as a school, park and mall are being built right around there now.
Summary of Numbers
Net Income: $84k/yr
- Spousal/Child Support: $7,000/month ($84,000/year) for the next five years.
- Occasional help from family to balance expenses.
- Car insurance: 1,600 year
- Home taxes : 1,800 year
- Cable, phone: 1,200 year
- Utilities, 1,100 year
- Electric, gas: 2,000 year
- Maintenance : 2,000 year
- Vacation: 2,000 year
- Entertainment: 700 year
- Gas: 4,000 year
- Child expenses: 3,000 year
- Home insurance: 1,600 year
- Groceries: 10,000 year
- Mortgage: 60,000 year (overpaying by $18,000/yr)
- TFSA: $15,000
- RRSP: $197,000
- Mortgage Balance: 435,000
- Credit card balance: $16,000 @ 1.99% (being paid off $1,500/month with help from family)
Divorce is tough and certainly a wealth killer but good on Heather for seeking advice on how to get her financial house in order. In her first email to me, her main question was about if she should sell her house now and lock in her equity because of the rumours of a real estate crash. To answer that question, I don’t have the foresight or experience in real estate to call a crash, however I don’t think a real estate crash is the main issue here.
The main issue is cash flow and the 5 year time limit on spousal payments. Right now, Heather is receiving about $84k per year (after tax) in spousal/child support but although this is more income than the average family, it is not enough for the lifestyle that she is living right now. Housing costs are eating up 75% of her net income, which doesn’t leave a lot for her and her son to live on. In fact, she is running monthly deficit which is evident in the credit card balance.
The good news is that Heather is currently overpaying on her mortgage, thus she can reduce her payments back to $3500/month which will free up $18k per year and bring her to cash flow positive. I would then take that cash flow and pay off any credit card debt and sever the family payments she is receiving.
The next step, and perhaps the hardest, is that she will need to downgrade her lifestyle. I understand that Heather is used to a certain lifestyle, but times have changed, especially with significantly reduced income on the horizon. I feel that Heather should sell her $1M house to either rent or use the equity to purchase a $300k-$400k townhouse free and clear.
By purchasing a townhouse, she will be left with about $100k cash lump sum in addition to reducing her annual expenses from $90k to $30k per year. If she sells her $1M home in the next year or so, it will leave her with $60k per year in excess cash flow or $240k over four years.
This will leave her in good shape as her potential $50k salary ($36k after tax and deductions) should be enough to cover her annual expenses once her spousal support runs out.
By following this plan, after five years she will have about $340k in the bank and a career that pays her enough to cover her annual expenses.
In the longer term, Heather is going for financial freedom by 50, or 8 years from now. This is very aggressive considering the financial situation she is in right now. Assuming a full annual TFSA contributions and 5% return, after 8 years the balance should be around $75k. Assuming no other RRSP contributions, the value of the account should grow $260k. If the $60k in mortgage payment savings over 4 years is invested for the 8 year term, the balance should be about $400k.
With these assumptions, total investable assets grow to $730k. The problem is that the time frame is only 8 years, and although the market has never lost money over any 20 year or longer period, the market can be very volatile over an 8 year period. In addition, with retirement at age 50, the portfolio would need to last 40 years or so.
Due to potentially long retirement time frame, I would invest in income producing investments that have a history of increasing their dividends (for inflation protection) and live off the distributions only. However in this case, even the portfolio managed to obtain a generous 4% yield, it is still not enough to cover her required $40k budget. On the bright side, if she stays invested for another 5-7 years and keeps maxing out her TFSA annually, she should be in good shape. Canada Pension Plan along with Old Age Security when she turns 65 will be icing on the cake.
I realize that this post was a little wordy, so here are the highlights of my thoughts on Heather’s financial situation.
- Reduce mortgage to minimum payment, use freed up cash to start paying down credit card debt;
- Sell the $1M house;
- Buy a town house for $300k-$400k;
- Put any cash left over ($100k) into TFSA (up to maximum amount), then the remainder into a non-registered investment account (avoid RRSP at this point);
- Invest old mortgage payment to add to non-registered portfolio ($60k/yr for 4-5 years); and,
- Start career ASAP, and create an aggressive budget so that TFSA can be maxed out every year without taking on any more credit card debt.
What are your thoughts about Heather’s financial situation?
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