Tuesday, August 11, 2009

The Psy-Fi Blog: The End of the Age of Retirement

This article is extremely insightful. Few people will be able to retire and most governments will not be able to afford the benefits that they've promised.
The Psy-Fi Blog: The End of the Age of Retirement

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Friday, August 7, 2009

Canadians falling further behind in paying their bills

The Canadian Press

TORONTO -- As the recession causes the financial squeeze to get tighter, a credit monitoring company says Canadians are falling behind on their credit payments at "an ever-increasing rate."

Equifax Canada says the average national delinquency rate at the end of June rose to 1.56 per cent -- a jump of 24 per cent over the same time last year.

Equifax defines a delinquent bill as one that's at least 90 days overdue.

The company says the province with the highest delinquency rate is Nova Scotia at 2.09 per cent, while Saskatchewan has the lowest rate at 1.24 per cent.

It says rates of overdue bills are increasing fastest in Alberta and British Columbia at 32 per cent and 30 per cent respectively.

Equifax says among major Canadian cities, Toronto has the highest delinquency rate of 2.03 per cent.

Thursday, August 6, 2009

Personal Finance and Home Purchasing

Something that I haven't quite got my head around is how so many (thousands per month) people can seemingly 'afford' to purchase homes in the Vancouver area considering the prices at which local homes seem to be sold at. Greater Vancouver benchmark for all dwelling types is just about $520,000 as of June 2009.

Let's look at a sample first time home buyer.

Let's imagine John and Jenny want to get started on the property ladder after getting married last year. They have saved $10,000 over the past couple years and they have about $25,000 in their RRSP accounts which they intend to use toward a property purchase under the Home Buyer's Plan. Jenny's parents have offered to help them purchase their first home as well with an extra $20,000 'loan' to be used toward a down payment that may never need to be paid back. They don't have any credit card debt but are making payments of a combined $900 per month on two car loans which have 3 years left on them. Combined down payment = $55,000.

John makes $60,000 per year working in the technology field and his job prospects are very good given his education and work experience. Jenny works in sales and her income has averaged $50,000 per year over the past two years. Although she does okay at work, her job prospects are sketchy as the company she works for has seen business drop off considerably and has laid off a few people in the last few months. Gross Annual Income = $110,000. Net Monthly Cashflow = $6,000.

They are wondering what they are able to afford (apparently they don't have a budget) so they go talk to a mortgage broker about their situation. The mortgage broker punches some numbers into the computer and comes up with a preapproval amount of $430,000. John and Jenny are amazed, they wonder what they have done to make the bank love them so much! This pre-approval emboldens them.

They call up a realtor and begin looking at homes in the $400,000 to $500,000 price range. The realtor shows them several condos and a few townhouses which meet their criteria and they settle on a nice townhouse and make an offer for $450,000 which is accepted and the deal is drawn up.

John and Jenny put $45,000 down by using the parent's money and withdrawing from their RRSP accounts under the Home Buyer's Plan. They have paid CMHC and legal fees of $9,000 which gets added to their mortgage so they owe a total of $414,000 and they have decided to amortize over 35 years (they will be 65 when it is finally paid off if they stick to the original plan with the original rate) with a 5 year term and a rate of 4.5%. They will be making principal and interest payment of $1,950 per month, they have added life insurance to the mortgage ($50) and are paying property tax monthly with their mortgage payment ($200). They now get to pay strata fees of $200 per month as well.

Let's have a look at John and Jenny's monthly budget.

John and Jenny's total monthly obligations are:
Mortgage - $1,950
Life Insurance - $50
Taxes - $200
Strata - $200
Car Payments - $900
Food - $600
Fuel - $400
Home and Auto Insurance - $400
Telephone/Internet/Cable - $300
Clothing/Other/Misc - $300
Entertainment/Vacations - $500
RRSP contributions - $200
Total = $6,000

This couple can have a 'reasonable' lifestyle based on these numbers but let's look a little closer.
Let's test this for several common risks:

Death - The mortgage is life insured, the survivor would be financially okay so long as the life insurance remains in place.

Divorce - They are in bad financial shape if this happens. Neither one of the two could afford the townhouse if they split up and the townhouse would need to be sold quickly.

Children - They are in bad financial shape if they have kids. Not only would they have extra monthly expenses, which they don't have room for in the budget, they would also have less income for a period of time as it is typical for the mother to take some time off work after giving birth. Even if mom went back to work there are daycare costs, which are not small.

Job Loss - They are a financial disaster if one of the two loses employment of any extended period of time. They would be forced to make some significant life changes and likely sell the home.

Interest Rate Rise at Renewal - If interest rates rise by 100-200 basis points they would be extremely rough financial shape. Unless they had an increase in income, they would likely be forced to re-amortize the mortgage and/or make other lifestyle changes. If rates increased more than 200 basis points, they would not be able to maintain their current lifestyle in any shape or form.
1) 100 basis point rise to 5.5%, maintain original amortization, payments rise to $2180 / month
2) 200 basis point rise to 6.5%, maintain original amortization, payments rise to $2420 / month
3) 300 basis point rise to 7.5%, maintain original amortization, payments rise to $2670 / month

Time - This is the most insidious risk of all and the least recognized. As a financial planner, I see many people who have put themselves into this type of scenario and they manage to muddle through life, manage to pay off a modest home by retirement and save a very modest sum of money. They retire at 65 and have a fairly low standard of living since they have no real significant savings and no pensions. If none of the above risks occured and they both managed to work a full career, get regular raises, contribute to CPP, receive OAS and have some modest RRIF withdrawals, they would make it through life without severe financial hardship but as a debt slave. The bank would have made over $400,000 from them in interest payments and they would have never saved much. They would live month to month their entire life and financial freedom would be a mere dream as they play the lottery each week hoping their number is drawn.

The reality is that the risks noted above are very real and for John and Jenny's situation to work out they need everything to work perfect, with no hitches, glitches or problems. This seems unlikely to me. It would be far better for them financially to leave themselves more room in their monthly budget so that they could:
1) Live / survive with only one income
2) Maintain mortgage amortization if interest rates rise
3) Speed up mortgage pay down by making extra payments as they receive raises if things work out well.
4) Increase their personal savings to RRSP and/or TFSA to ensure they have money for the unexpected and for retirement.

There are only two ways for John and Jenny to make the above work in a sustainable manner:
1) Continue renting and saving aggressively
2) Buy a much cheaper home and aggressively pay down the mortgage

What are your thoughts? Do you know John and Jenny? I do.