DAVID HUTCHINSON 778-839-5442 DAVID.HUTCHINSON@CENTURY21.CA
Financial planner and FP columnist Jason Heath helps readers shed light on difficult financial decisions. Send your queries to email@example.com.
Jeff asks: I’m recently divorced and trying to figure out the best course of action on purchasing a condo for myself. I’ve been approved for up to $330,000, but I don’t want to go that high as I’d prefer to have money left over to pay for any other expenses, travel, fun, etc. and of course be ready for any interest rate increases in the future. I’m assuming my new mortgage amount will be $290,000 to $300,000 with a monthly condo fee of $400. I will need to use my RRSP, my TFSA and my emergency fund.
Am I squeezing myself too tight?
I think rushing to make financial decisions when you’ve had a big change in your financial life is a bad approach
Jason Heath answers: Jeff has a few good things going for him. Interest rates are low, so that helps people qualify for more mortgage than they would normally qualify for. This is a good thing when he’s selling a house in the burbs that he lived in with his wife and moving into a condo that he’s going to have to pay for on his own.
He and his spouse made a clean split and there are no ongoing financial obligations between each other. So he can start with a new slate from a variety of perspectives, but in particular, with regards to his finances.
Today’s low rates are both a good thing and a bad thing.
He will be debt-free other than a potential mortgage on a planned condo purchase. He also has a $5,000 emergency fund, $5,000 in TFSAs and $41,000 in RRSPs.
Most importantly, Jeff doesn’t have or presumably need a car. Cars can be a big expense, not only on an ongoing basis, but also on a sporadic basis as repairs are required.
Jeff has a few bad things going against him. Interest rates are low, so that helps people qualify for more mortgage than they would normally qualify for. And yes, I did already state this point, but no, it’s not a typo. Today’s low rates are both a good thing and a bad thing.
What happens if rates double from 2.50% to 5% on renewal of his mortgage in five years? His monthly mortgage payment will jump from $1,344 to $1,669 – an increase of 24%. What if rates triple to 7.50%? Payments will increase by 51% to $2,028 per month. And for those of you who think 7.50% is unheard of, it’s important to remember that prime was at 6.25% a little over five years ago, in November 2007.
What if Jeff gets squeezed on the increased payments in five years and has to sell the condo? If home prices continue to increase, it’s not so bad, he’ll make a profit. But what if there’s a 20% correction in real estate prices, as there was in the late 1980s in Canada? His proposed $315,000 condo would be worth only $252,000 and his mortgage would be $254,000. After real estate commissions, legal fees and other transaction costs, he’d be in the hole about $15,000 after having paid $35,000 in interest costs over the previous five years.
One problem Jeff is going to run into is that he plans to use $15,000 from his RRSP as his 5% downpayment. Unfortunately, the Home Buyer’s Plan program that allows withdrawals of up to $25,000 from your RRSP for the purchase of a home is only available to first-time homebuyers. A first-time homebuyer is someone who has not owned a home in the previous five years.