Couple who used their home as an ATM in a cash crunch amid housing recession

Rising interest rates have given them a double whammy as they try to sell their current home and buy a new one.

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Editor’s Note: After more than a decade analyzing the finances of hundreds of Canadian families, Andrew Allentuck hangs up his hat as FP’s Family Finance columnist. This will be his last column. He stay tuned for the new Family Finances, coming soon.

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A couple we’ll call Ernst, 52, and Molly, 48, live in British Columbia. They have a combined gross income of $178,000 per year from their jobs in technology and hospital administration, respectively, taking home $10,075 per month after taxes. They’re in the process of buying a new home, but the market has thrown them a curve: Rising interest rates have pushed down the price of their current home and raised the monthly cost of the mortgage they’re buying. They have spent most of their savings and are now in a cash crunch. It is a serious financial jam.

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They thought their current house would sell easily for $900,000, but they have no offers for an asking price of $850,000, just above their $790,000 mortgage. They also agreed to pay $1,050,000 for a new house, on which they put a $50,000 deposit. They need $275,000 to close on the new home and will need to cover $40,000 to sell their old home, including $35,000 in fees if they want to get out of their current mortgage. That’s a total of $315,000 in cash that they need to complete both transactions. They have $90,000 in cash, a drop in the bucket.

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Asset cabinet is empty

Aside from cash and houses, his other assets are meager: just $11,000 in mutual funds and a $27,000 car. They do not have RRSP or TFSA. Everyone will have a defined benefit pension, but the capital behind the pensions belongs to the insurance companies that will pay the pensions. It would be expensive to access as a switched value and then only with heavy taxes and deep discounts, but it is an option that they will have to consider to complete the initial payment.

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Your liabilities include the mortgage on the old house of $790,000 and the mortgage on the new house of $1,050,000.

Family Finance asked Derek Moran, director of Smarter Financial Planning Ltd. in Kelowna, BC, to work with Ernst and Molly. The couple’s problems are not financing retirement, but paying for their new home.

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“They have minimal net worth on their balance sheet, but they’re not poor,” Moran explains. “There is a big difference.” The old house is not a financial disaster, she says. They paid $615,000, so they have had what amounts to free hosting with a capital gain. However, instead of paying off the mortgage over time, they have used their capital as an ATM. It is reaching them now.

rental suite

A rental suite in your new home can be valued at $250,000. The rent they receive will make it self-financing and then produce additional cash flow.

They should have a real estate agent provide a written opinion on the value of the rental suite, Moran suggests. The cost of the mortgage related to it will be tax deductible, so they should pay it off slowly and concentrate the payments on the cost of their own accommodation, which will not be deductible.

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They could get a two-tier mortgage: one for their own home and one for rent. That would keep your accounts clean for CRA reporting, Moran suggests.

retirement income

If it weren’t for the large mortgage balance caused by overspending, they could retire early. However, to make up for it, they have agreed to work until Molly is 65, when she will have an indexed pension of $35,000 per year. Ernst, beginning the same year (when she is 68), will have a non-indexed pension of $26,703 per year. Each member can expect Canada Pension Plan benefits of $15,043 at age 65, the current upper limit. At age 68, when he retires, he’ll get an 8.4 percent annual raise, bringing his CPP to $18,834 a year. At 65, Molly will earn the base amount.

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Each will have full Old Age Security, $8,000 per year with available bonuses of 7.2 percent for each year they delay starting beyond age 65.

Molly’s annual pension will be $35,000 and Ernst’s will be $26,703 plus $18,834 enhanced CPP and $9,728 enhanced OAS. Molly can add her own OAS of $8,000 and a CPP of $15,043 at age 65. That would make a total income of $113,308. After dividing the income and the 17 percent average tax, she would have $94,045 per year or $7,837 per month to spend.

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Solving the cash crisis

Ernst and Molly still need to raise $275,000 to complete the purchase of their new home. Selling their old house for an estimated $850,000 less $40,000 in fees and paying off their $790,000 mortgage will leave them with $20,000 to add to the $90,000 they could raise, but still very little left. Commutating one of your pensions is one option, but it would permanently reduce your income in retirement. Relying on credit cards is never a good long-term solution, but in this case it might help. Income from the rental suite and money that used to go into savings could be diverted to pay off that debt. Getting a loan from a relative would be another option, or a combination of all of the above.

They are in their dilemma because rising interest rates have dealt them a double whammy: deflating the market for their old home and increasing the cost of the mortgage on the new home. Over time, their debt will be reduced and they will be able to pay off some of the cost of the rental suite mortgage. Molly and Ernst have a cash crisis instead of a date with bankruptcy.

“As long as they pay down the debt within the current low- to mid-single-digit interest rate outlook, they will come out of the cash crisis in good shape,” says Moran.

Retirement Stars: 2** out of 5

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