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financial facelift

Ashley.Galit Rodan/The Globe and Mail

At age 32, with a well-paying job in health care, Ashley wants to buy a place of her own in pricey Toronto. She has other goals, too – she may want to have a child at some point, and she hopes to ease out of the work force at age 60. But that’s a long way off.

Ashley earns $110,000 a year – a figure that could rise over time. At age 65, her defined-benefit pension plan will pay her a lifetime pension of about $60,000 a year, indexed to inflation.

Of course, a lot could change between now and then. For now, Ashley wonders if her goal of home ownership could impinge on her other goals.

“Will I be able to afford a down payment on an $800,000 primary residence?” Ashley asks in an e-mail. “I think I would need $100,000 for a down payment, and it might take me three more years to save this amount,” Ashley writes. “I checked with an online calculator and I would qualify for a mortgage for the balance.” Would buying a home and taking on such a large mortgage leave her feeling house poor?

We asked Stephanie Douglas, a financial planner and co-founder of Harris Douglas Asset Management Inc. in Toronto, to look at Ashley’s situation.

What the expert says

“Buying a place to live could be one of the most important financial decisions Ashley makes, and it could well affect her ability to achieve her other goals, so it’s important to look closely at what it might entail,” Ms. Douglas says.

Ashley has $53,500 saved so far and is contributing $200 a month to her tax-free savings account. She has an annual surplus of about $22,000.

“If she saved her surplus in addition to the $200 a month she is saving already, Ashley could achieve her goal,” the planner says. “She would have about $130,000 in three years,” assuming a 1.25-per-cent interest rate in a bank savings account.

In addition to her down payment, Ashley will need enough to cover closing costs and land transfer tax, which would normally total about $25,000 on an $800,000 property. The tax will be reduced to about $16,000 because she is a first-time home buyer, the planner says. Other closing costs, such as legal fees and title insurance, could add another $4,000.

If Ashley puts down less than 20 per cent, though, the loan will be considered a high-ratio mortgage and she will need mortgage loan insurance. “Based on buying a property of $800,000 with a $100,000 down payment, she would be looking at mortgage insurance estimated at $21,700, plus provincial sales tax,” Ms. Douglas says.

Instead, Ashley may want to save a little longer. “While it would take Ashley longer to save a 20-per-cent down payment, she could avoid the additional cost of mortgage insurance,” the planner says. She suggests Ashley meet with a mortgage broker when she is ready to buy so she can get a more accurate estimate of all the costs involved. “This will also ensure that she is up-to-date on any new first‐time home buyer incentives.”

(For example, the federal government is proposing a First Home Savings Account for people under age 40 to save up to $40,000 toward a down payment.)

To qualify for mortgage insurance from Canada Mortgage and Housing Corp., Ashley would need a debt service ratio of less than 39 per cent, Ms. Douglas says. “This means that payments for principal, interest, taxes, heating and half the condo fees, if applicable, cannot exceed 39 per cent of her gross income, or $3,575 monthly based on her current income,” the planner says. “Getting a pre-approval before starting her home search is the best way to get a more accurate idea of how much she can spend.”

The five-year fixed mortgage rate is about 2.5 per cent, which, on a mortgage of $721,700 (assuming she rolls the cost of mortgage insurance into her mortgage), would mean a monthly payment of $3,233, the planner says. This assumes a 25‐year amortization, the longest possible for a high-ratio mortgage.

“This means she could spend at most an additional $342 a month on taxes, heating and 50 per cent of any condo fees,” the planner says. “Given her lifestyle expenses, including her TFSA savings, and assuming $3,575 monthly for housing, she would have a surplus of only $155 a month,” the planner says. “This does not leave a lot of room for her other goals.”

While Ashley’s situation could change over the next few years – she could get pay increases that make her home purchase more feasible, for instance – “I would suggest that she save longer or consider buying a less-expensive property,” Ms. Douglas says. “She could also look for areas of her budget to trim over the next three years to increase her down payment – for example, getting creative with gifts to lower the $250 monthly she currently spends,” the planner says. “I suggest keeping housing costs to a maximum of 30 per cent of gross income, which in Ashley’s case would mean $2,750.”

Before she buys a property, Ashley should also tuck some money away for an emergency fund.

Not having one could result in a debt spiral if unexpected costs such as home repairs come up, the planner says. She recommends setting aside three to six months of living expenses, or about $12,000 to $25,000. Ashley should increase this number after she buys the property to reflect her higher housing costs.

Ashley has her savings invested in a mixture of stock and fixed-income exchange-traded funds. While the performance has been good – and may help her achieve her down payment sooner if the market does well – if the market falls, it could derail her three‐year plan, Ms. Douglas notes. “Because investing is highly emotional, she may panic and sell her stocks at a loss, especially if the market happens to fall close to her target date.”

If that happened, Ashley may need to delay her home purchase, buy a cheaper house, or make a smaller down payment – potentially taking on a larger mortgage in the process, the planner says. Keeping funds in cash would also allow her to take advantage of a potential drop in housing prices.

Ashley is in a high tax bracket and is a first‐time home buyer, so it might make sense for her to take advantage of the federal Home Buyers’ Plan, where $35,000 in an RRSP account can be used toward buying a first property, the planner says. Ashley has $40,900 of unused contribution room. “The advantage of using the home buyers’ plan is that she will be able to decrease her taxable income by claiming RRSP contributions, enabling her to save even more toward her down payment,” Ms. Douglas says. “This could get her to her down payment goal more quickly.”

Funds withdrawn under the Home Buyers’ Plan will need to be repaid to her RRSP over 15 years, starting two years after the first withdrawal. Any funds borrowed must have been in the RRSP for 90 days or more before they can be withdrawn.

Client situation

The person: Ashley, 32

The problem: Can she afford to buy an $800,000 home?

The plan: Try to save at least a 20-per-cent down payment, plus closing costs, to avoid paying mortgage insurance, even if it means waiting a little longer.

The payoff: A realistic idea of how to proceed.

Monthly net income: $7,000

Assets: Bank accounts $30,000; TFSAs $23,500; contributions to date to defined benefit pension plan $18,000. Total: $71,500.

Monthly outlays: Rent $1,800; home insurance $25; transportation $265; groceries $200; clothing $150; gifts, charity $300; vacation, travel $200; dining, drinks, entertainment $600; personal care $100; sports, hobbies $200; subscriptions $50; health care $50; health and dental insurance $15; life, disability insurance $110; communications $130; TFSA contributions $200; pension plan contributions $700. Total: $5,095. Surplus $1,905.

Liabilities: None

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Some details may be changed to protect the privacy of the persons profiled.

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