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By: Catherine Mulroney
The Globe and Mail
Globe Investor Section,
Saturday, December 28, 2002
Mike Murphy and Sandy Taylor (not their real names)
have one overriding criterion in their search
for a home: They want to be on the subway line
in Toronto.
"We're urban people," Mike explains. "We're
simply not interested in moving to the 'burbs. We like
being able to walk to shops and restaurants."
By staying on the subway line, they also figure they
can stretch the life of their car, a 1994 BMW.
But in Toronto's hot real estate market, the question
for the recently married couple is how much house they
can afford, particularly since a centrally located house
is going to come at a premium. They currently live in
a one-bedroom condominium that Mike bought in 1997 but
are finding the marriage of their possessions is making
things tight. Adding to their desire to move to a bigger
space is the fact they plan to have children within
a couple of years.
Adrian Mastracci, financial
advisor at Vancouver’s ‘fee-only’
KCM Wealth Management, says, “The decision
on what kind of property to buy and how to finance
it is ultimately a personal choice that reflects
their way of life.”
The two are trying to decide whether they should sell
the condominium and put the proceeds toward a bigger
property or whether they should keep it as an investment,
rent it out and settle for a smaller down payment on
a second home.
"We think it would be a good investment opportunity
to have someone else pay for the mortgage on the condo,"
Mike says in explaining the appeal of the latter scenario.
If they sell the condo, the couple figure they could
afford to pay about $450,000 for a house, given that
the condo has been appraised at $190,000 and has an
outstanding mortgage of $95,000. Mike calculates they
could ask between $1,400 and $1,600 in rent for the
unit. Currently, the couple are paying $900 every two
weeks in mortgage and taxes.
If they were to hang on to the condo, they figure they
could access about 60 per cent to 70 per cent of the
equity for a down payment and swing a second property
valued at about $350,000.
Life is comfortable for Mike and Sandy. He makes $72,000
plus a bonus as a software consultant and she makes
$82,500 plus a bonus as a consultant in the financial
services industry.
Beside the condo, the couple's assets include his registered
retirement savings plan, which stands at $82,000; hers,
which has a value of $52,000; an emergency fund of $12,100
and investment club stocks of $10,700.
While they have gone on-line to look at what's out
there, "we won't seriously start looking until
May or June," Sandy says, noting that gives them
the time to decide how to finance their next home. "We
don't want to get into a bidding war."
The upside, however, is that "at least we know
that if we're buying high we're also selling high,"
Mike adds.
What our expert says
"Mike and Sandy should be congratulated for doing
many right things, especially paying themselves first
by making RRSP deposits and the property purchase,"
says Adrian Mastracci, president
of KCM Wealth Management Inc.
in Vancouver. "It's refreshing to see a couple
not spending 150 per cent of what they earn."
The decision on what kind of property to buy and how
to finance it is ultimately a personal choice that reflects
their way of life, Mr. Mastracci stresses, but adds
there are potential pitfalls the couple need to remember
when mulling over the possibility of becoming landlords.
Even by renegotiating their mortgage, at best the net
rental income would likely be small after all expenses,
he notes.
"What with mortgage, taxes, insurance, repairs,
they would face all the expenses associated with ownership,"
Mr. Mastracci says.
But one of the biggest problems the couple could face
would be the possibility of vacancy, he adds, noting
that carrying two properties could become an expensive
burden for Mike and Sandy and eat into their savings.
"It would be a shame to see a couple like this
find themselves with too many things in the air, given
the discipline they've demonstrated," he says.
Selling the condo and buying a house with the proceeds
presents more obvious benefits, he adds. With only one
mortgage, their expenses would be predictable, because
they would not need to factor in a tenant, Mr. Mastracci
notes. And with more money to put toward their purchase,
they'd be in a better position to afford a property
that would accommodate their plans for a family.
Assuming the net cash from the sale of the condo was
$85,000, they could accumulate more of a down payment
from existing sources, such as the investment club funds,
he adds.
As the home would be the couple's principal residence,
the mortgage interest would not be deductible and so
Mr. Mastracci recommends opting for as short an amortization
period as possible to save thousands of dollars in interest.
To demonstrate, he suggests looking at the arbitrary
example of a $100,000 mortgage, amortized over 25 years.
Assuming, for the sake of the example, an interest
rate of 6 per cent, the couple's monthly payments would
be $640, and they would pay $91,400 in interest over
the 25-year period. But if the amortization rate were
shortened to 20 years, monthly payments would rise to
$712 and the interest paid would drop to $70,900, for
a savings of $20,500.
"This couple should keep it simple," Mr.
Mastracci says. "They should concentrate on getting
rid of their mortgage and keeping up their RRSP contributions.
It's a one-brick-at-a-time approach."
Client situation
Mike Murphy, a software consultant and Sandy Taylor,
a financial services consultant, are in their early
30s.
Annual income
Their combined annual income is $154,500, plus bonuses.
Assets
Condominium, $195,000 ($95,000 mortgage outstanding);
1994 BMW, $5,000; RRSPs, $134,000; non-registered investments,
$10,700; cash $14,000; jewellery, $20,000.
Monthly household expenses
Mortgage and taxes, $1,800; condo fees, $315; parking,
$175; savings account, $1,500; cable, phone, Internet,
$200; groceries, $200; restaurants, $500; gas, $100;
mobile phones, $70; bus pass, $90; RRSPs, $2,700; car
and home insurance, $165; life insurance, $230; investment
club $200; grooming and clothes, $300.
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